The Compleat Trader

Waiting for Godot...

noreply@blogger.com (Neeraj M) — Sun, 09 Feb 2014 07:40:00 +0000

That is how the situation looks like. In a policy limbo for last three years, we have been waiting for the government to do something. Something decisive. The wait has become so elusive, it is almost pathetic.

When you start searching your memory when anything constructive was done last, you have to search really far and wide. The growth spurt that happened was either the result of easy money, or was riding on things that happened well before the last ten years. The telecom boost, the infra spurt started with golden quadrilateral and so on. The big thing that stands out is the nuclear deal. What else? The late 'surge' shown last year is also a mirage. FDI in retail will do exactly what? Large format retail needs large land pockets. Try buying land anywhere close to a large city in pockets like 20 acres, all the 'cost efficiency' goes down the tube right there. Who will drive 50 kilometers to save 5% on groceries? And what happened to WalMart when they tried opening a store? Unless a broad real estate reform is done, FDI in retail is DOA at best. What else has exactly been done in last ten years? Please drop me a line when you can recall what exactly has been done for the economy.

The irony is that everyone is just waiting now. Waiting for elections and waiting for deliverance of some sort. We are waiting for one saviour, one reformer, who has his / her policy thinking right, who can separate the populist stuff from economic substance. Hopes are being pinned on certain Mr. M. But when he speaks up on policy, the best that emerges is a muddle with no clarity. The party with a difference is proposing abolishing all taxes, and slapping a penalty (it is a penalty really) on those who are stupid or unfortunate enough to route their money through the formal banking system. Blessed are those who do everything in 1000 rupee notes, stuffed in large sacks. From now on, not only do they get away with paying nothing, but will be paragons of virtue also because paying no taxes will be fully legal. The Mr. G with a difference should also explain what he will do when everyone stops using the banking system and hundi and havala become the dominant 'economic channels'. What a path to prosperity.

On top of it all, we have found an 'alternative' to all the dirty politics. The great thing about this alternative is that the solution to all the problems is either a sting, or a vigilante law where the accuser and the investigator and the judge are just one person and that person can jail anyone on a whim, or a simple dharna. This is a great solution. No healthcare for the masses, not enough schools, no money to buy electricity, vegetables are too pricey; there is nothing a good dharna cannot solve.

So we are waiting for a policy messiah and for someone who can just decide. A lot of names will be thrown in the fray. With vehement denials, the dharna party has not only pressed ahead with everything populist but has also started radio ads touting the 'progress' made in one month. Sounds a little bit like 'char mahine banaam chaalis saal', the campaign slogan of the Chandra Shekhar government of 1991. I wish it doesn't become what became of that government; a nightmare that we will all like to forget. We have the regional kings and queens all vying for the national crown. With all the princes, kings, queens, chaiwallahs and jhadoowalas, there will be fair bit of choice for everyone. But will the messiah who will lift us out of this limbo of joblessness, crushing price increases, complete lack of movement on anything concerning the public (roads, bridges, power plants, water treatment facilities and so on, after all these are called 'public goods' for a reason) ever arrive?

The real nightmare is that it may turn out to be a wait like the one for Godot, when at the end of it all we don't even know whether the famed character, name it Godot or the messiah, even exists...

Making sense of data...

noreply@blogger.com (Neeraj M) — Sat, 08 Feb 2014 15:16:00 +0000

A lot of times, we see that market participants display complete disregard to facts and data. We do it all the time when we look at information that has bearing on the economy and the stock markets. The latest one to come up is the CSO estimate on 2013-14 GDP growth for India. For the first three quarters, we have seen sub-5% growth. The Finance Minister still maintains that 5% growth is possible and CSO estimates 4.9%.

The tricky bit to remember is that these are either advance estimates or early estimates. Actual data takes some time to collect and is subject to revision. For instance, the last year GDP growth estimate got revised down to 4.5%.

It is not that the CSO would be releasing high estimates as a matter of habit and later revising it downwards as actual data flows in (though some would be cynical enough to say that). What really matters is the way data is collected and processed. Since a lot of estimates are just extrapolation, the quick estimates will overestimate information in a downcycle (as data points are trending down on a progressive basis, the extrapolation will overestimate compared to actuals) and underestimate information in an upcycle. Hence, estimates tend to get revised downwards in a downcycle and upwards in an upcycle as actual data flows in.

I am not arguing again on the data validity. Instead, my point is that the downward revision for the last year GDP means that we were in the middle of a downcycle as we entered this financial year. It also implies that the 1st and 2nd quarter GDP is likely to have been overestimated. Combined with the IMF estimate of 3.8% growth for calendar 2013, it means that 4.9% is very unlikely to be reported for the current year; not even in the quick estimates and certainly not in the revised estimates.

That and information from other indicators (IIP, etc.) and the information collected anecdotally indicates that we need to prepare for a much worse number to be printed than 4.9% or 5%. Those who insist that the Indian economy has turned the corner are in for a rude shock. For one, the local and global cycles are aligning again. While Europe is staring at deflation (and will pump in more money to revive the economy, we will know in June whether ECB will do QE), both the housing markets and the equity markets are overly exuberant. It is not only the Indian market that is running ahead of itself, it is now a global phenomenon.

On the whole, it is not a good combination. As we head into perhaps the most crucial elections in last 17 years, fissures are appearing elsewhere too (the frequency of hiccups from China is also growing). This may be the set up for a major correction and further downtrend on the GDP. India has never bottomed out at 5% GDP growth in a downturn. And this time, it looks even more unlikely.

Back after a long hiatus...

noreply@blogger.com (Neeraj M) — Tue, 04 Feb 2014 13:44:00 +0000

The last series that I intended to post was supposed to be a commentary on the fiscal mess India was getting into and how markets have been deceptively benign to India. I wanted to show that markets can be very cruel and what happened to Spain in 2012 could happen to India any time. As it happened, I lost my notes for all 21 chapters, and just lost the will to recreate the train of thought.

But the issue is as relevant today as it was then. We are nowhere out of the precarious situation, though people are more cautious post the shock we got in July and August, 2013. At the same time, the macro trends that were set in motion over past five years are still in full play and the consequences will be there for all to see. Make no mistake about it, we are still headed for a lot of pain unless there is some serious intervention.

There are a few positives that have happened in past one year. We have a central bank governor whose policy action is based on some understanding of macro economics; who is willing to base decision on sound economics rather than banking traditions (question: what created the global bubble and financial crisis to begin with?). This means the RBI will be better prepared to deal with the mess as things unfold. There is also a belated realization that gross economic mismanagement is a sure fire way to lose elections, populist gimmickry notwithstanding. Still, the populists have a lot going for them, a shrill voice, faux concern for the poor / middle class / name what you like here, and some spineless resistance by people who are supposed to know better but choose to step out of line of fire.

The big question of how markets will behave still remains. I cannot predict where they will go. I can only point to what can happen. What can happen is that markets can be incredibly cruel and unforgiving, that they can stay negative far longer than fundamentals warrant (the flip side is true and is already happening, the markets have been quite positive despite fundamentals being in complete mess), that once the markets get in a punishing mood, they can bring any economy to its knees. I wanted to show that comparison in relation to Spain; an economy that was roughly the same size as India in 2012, is an EU member, is a developed economy and so on. But the country stayed literally under siege till ECB came to its rescue.

We carry the same risk and I think part of that risk will materialize in 2014. The developed world is growing again, though markets are running ahead of themselves there too. QE is unwinding, though it seems likely that ECB will now need to start doing some QE of its own too. Still, the rest of the world is becoming more attractive, and that takes the wind from under the sails of the argument 'India is still growing at X%, which is much better than the rest of the world'. Fact is that there is a complete neglect of economic history in this country. And if you look back, the fact will emerge that India has recorded negative GDP growth, both on quarterly and annual basis. Also, the fact will emerge that India has never bottomed out quarterly growth rates like 4.5%.

The above statistics are based on old paradigm. Guess what? The new paradigm is scarier than old paradigm. Prior to 2005, India maintained a decent manufacturing infrastructure. Industry was shielded by non-tariff barriers and also a perennially depreciating currency. Since 2005, we have seen both openness and an appreciating currency happening simultaneously. The result has been decimation of the industrial sector, which does not bode well for a recovery. For the very first time, we are also seeing declines in the services sector too. That leaves agriculture, which provides a feeble defense to a prolonged slowdown or a relatively high rate of growth in a 'bottoming out' quarter.

The prognosis is nowhere close to clear. The real risk lies in our policy responses. None of the warning signs have been used for setting our house in order. Pressure comes, and knee jerk reaction happens (reduce gold imports, jack up interest rates to bolster the currency, and so on). Then something else happens (Abenomics, ECB action, delayed tapering) and we go back to the 'good old days' of merrymaking.

To come up with any conclusions, a lot of things need to be watched. Like the rise of AAP, there is too much that is unprecedented, throwing away all old calculations out of the window. We are in for some interesting times, to use a cliche.

Where Else Will the Money Go?

noreply@blogger.com (Neeraj M) — Sat, 21 Jul 2012 12:46:00 +0000

Episode 4 - Perverse Incentives

This 21-part series (excluding the prologue and the epilogue) examines the challenges facing India and the economic headwinds. The title of the series comes from the book Breakout Nations by Ruchir Sharma, from a nouveau riche kid in New Delhi quoted by him. The quote captures the confidence, almost arrogance, that India has built up during the last decade, which is not limited to rich brats and extends to business tycoons, policy makers and politicians alike. The series tries to separate the myth from the fact, and examines some hard choices the country will have to make over next few years.

First things first, the 'perverse' in the title has nothing to do with anything outside economics. It is standard economic terminology applied to an examination of situations where actual outcomes differ vastly from outcomes that 'rational' people intend. In its core, it is achieving, with thumping success, what you set out to avoid in the first place.

The reason why I am digging up the concept is that it is probably the only explanation behind so many policy debacles we face today in the country. The reason behind diesel subsidy, for instance, is avoiding inflation. But the very subsidy, as it gets ballooned by 'players' along the chain taking their 'cut', comes back in the shape of fiscal deficit. It ultimately causes a far bigger impact through a generalized inflation, the impact becoming bigger with multiple perversities adding up on the way. Cheap diesel means it is economical to run older, highly inefficient vehicles and machinery. It also means people start buying diesel cars, which cause far more pollution, cost more to make and are difficult to maintain. It also means that industry can keep on getting cheap substitute power through DG sets (if power is correctly priced, at least there will be some incentive to use more efficient, and thus economical, ways to produce). And it also means that people living in swank houses and condos use up far more power than they need through 'DG backups' (which, incidentally, are used for at least 8-10 hours a day in almost all the cities in India). The end result is that far more diesel is used up than it would be had there been no subsidy. On top of that, no private company is willing to enter petro-distribution due to the screwed up policy. Hence, you have government monopoly that is adding its own inefficiency to the system. You end up paying for it all, through a much higher level of inflation than would have resulted had diesel been allowed to be priced at market levels.

This is a pervasive situation in India. No matter which policy area you look up, the outcome seems to be the opposite of intent. Power sector is comatose, though with the given energy deficit in India, it should be booming (and it was booming for a while). States are opposing GST, though they lose thousands of crores through evasion every year as the current structure makes it easy to steal. Fertilizer subsidy is primarily putting money in the pockets of fertilizers producers, instead of farmers who it is supposed to benefit.

Currency policy
The currency policy the country has followed over the past decade can be explained in this context. It is not that we started out intending to do this, but it eventually turned out to be a policy that has harmed the industry; like so many other well intended policies.

Beginning with 2004, India started attracting huge capital flows. Most of the flows were still of the 'hot money' nature, FII flows that could be pulled out of the country any time. The RBI, at that time, had a strong policy of 'sterilization', i.e., insulating the economy from any monetary effects of the same. Thus, excess dollars were mopped up and the central bank issued sterilization bonds to mop up the excess rupee flows created by such conversion. In effect, the effect of inflows was completely neutralized.

But this policy was quietly dumped soon after 2004. The conservative policies of the NDA government were abandoned and UPA-I became eager to show a great score card. And currency as a tool came in handy, an appreciating currency itself starts to attract higher capital flows. Thus, from FIIs putting money into the stock markets to investors putting up power plants, the returns suddenly became attractive because whatever you make on your investments in rupee terms gets further boosted by currency appreciation. India used to be a country where you always worried about currency depreciation before investing. Instead, now you no longer had to worry about depreciation, and if there was any risk, it was more to the upside.

Why are these capital flows important to India? Because domestic capital formation has been inadequate to fuel the hectic pace of growth that became the norm during middle of the last decade (that is a separate debate altogether). Suddenly, you had everyone lining up to invest in India, and Indian firms also became big borrowers in the international market. The herd was on the move, investments started ticking up, the GDP growth gained momentum. The best part of it all? The government didn't have to do anything to make it happen, no painful deals with allies, no unpopular reforms. All they had to do was to tweak a thing or two like letting the rupee appreciate. And you were delivering 9% growth, something India had only dreamed of.

Building its own momentum
But these things tend to create their own momentum. By 2008, we had built huge risks into the system due to the overvalued currency. People who had borrowed dollars or had poured money into India in 2007 with rupee at 40 per dollar suddenly looked vulnerable in 2008 as first set of shock waves started to hit India. Suddenly, everyone who had anything to do with dollars started looking like on the verge of collapse.

The impending collapse looked scary at the moment. Investors would lose huge amount of money on the currency, apart from losing their shirt in the stock market. Entire corporate sector would lose profitability for at least a couple of years, if they avoided bankruptcy in the first place. On top of that, exporters had earlier joined the bandwagon as selling dollars forward looked like an easy way to make money. If you sell a year ahead, you not only lock into the current dollar rates, but make a premium on top of that too. With dollar going only one way, down, the temptation was huge. Exporters not only sold forward for one year, but more ambitious folks went ahead to sell several years forward. And where RBI rules did not allow selling so far ahead, banks came up with 'innovative' structures like dollar call options, where the seller was paid a premium upfront to make the bets. The gravy train was set. And when the tide turned, these very people stood to lose everything as the realized losses would wipe out a big chunk of their net worth.

Given the environment in 2008, policy choices were limited. Risking collapse at such a large scale would have been imprudent, so the interventions (rightly so) were aimed at protecting the currency. But as we have learnt from the experience elsewhere, we created our own 'too big to fail' problem. People do not use such opportunities to let the poison out of the system. And we also did not. Instead, the imbalance has been allowed to carry on.

This is the essence of today's conundrum. The moment currency depreciates a little bit, there are howls of protest as the pain is excruciating among all, including people who should logically benefit from a weaker currency. We have created our own vicious currency cycle.

Is the 'worst' over?
Over past month or so, we have seen the currency stabilize around 55 level. Many have assumed that the worst is over and rupee will start appreciating again. But this is not a given.

Reality is that years of imbalance have created fundamental issues with the economy. Our current account deficit, for instance, has hit an unsustainable level of 4.5% of GDP. This is enough to create doubt in the minds of some people. The challenge today is that even a small doubt is enough to stop the stream of money from coming in, and that flow has become essential to plug the gap in the current account.

And this situation is not likely to ease any time soon. The exchange rate study that I cited in an earlier episode also found another piece of vital evidence. In early 2000s, currency changes were feeding through in the export-import system with a lag, which is logical. It takes time for people to adjust their cost structures, pricing, etc., and set up new contracts to factor in new exchange rates. The lag I calculated for 1994-2004 period was around 18 months. This time around, lag is likely to be longer, particularly on the export side.

Enduring pain
The only sustainable solution to an unstable currency is a pickup in exports and correction of the huge trade imbalance. This is not likely to happen any time soon.

Till 2004, while exporters did sell dollars forward, they were naturally wary of creating too much risk and sell too far ahead. The currency was prone to sudden bouts of depreciation, which meant whatever gains they made from forward dollar premia could be wiped out many times over if they took too big a risk. Still, they were taking about 18 months to register higher sales in case there was a serious currency devaluation.

At this moment, however, the same assumption is not true. The risks extend well beyond a year, though they have become far shorter than those seen in heady days of early 2008. Exporters are still locked in poor or toxic hedges that will keep their cost structures in bad shape for at least another year. This means pass through of more competitive exchange rates is likely to take longer than 18 months seen in early 2000s.

The external environment does not help. Given the global 'doom and gloom' scenario, export demand continues to be weak. This means currency pressures will continue for some more time. And the moment the tide turns again on investment money, the pain will start all over again.

Where do we go from here?
I have usually avoided predicting a definitive version of the future. It simply does not work, except for large financial houses. This time around, the predictions are on familiar lines. You keep hearing that the 'fair value' of rupee is somewhere between... (plug in your favorite range, based on your choice of bankers). The hilarious part is that the range usually happens to be within 2-3% of where the currency currently is.

Predicting in the current environment is especially risky. The truth is, no one knows. We don't know how long the global demand slow down will last. We don't know if portfolio flows will continue. We don't if investors will keep on tolerating the policy logjam we have created. And we don't know if players in the system have systematically removed risks (e.g., by hedging short term loans) or have allowed them to be there hoping for another 'too big to fail' based largesse.

What can be said, however, is that the current situation is finely balanced. And downside risks in such situations can be perilous. One bit of bad news, a gentle nudge, can start a chain reaction. And the effects can last for a long time.

Where Else Will the Money Go?

noreply@blogger.com (Neeraj M) — Wed, 11 Jul 2012 10:23:00 +0000

Episode 3 - Of Currency and Value

Countries ranging from Japan to China, Germany to Argentina, have tried to manage their currencies in order to stay competitive. A weak currency was a 'weapon of choice' for the BOJ during the '90s to keep the industry afloat. China, likewise, has faced persistent pressure from the US to allow its currency to appreciate and relented only by middle of the last decade. Why would these countries push so hard for keeping their currencies cheap even though their economic fundamentals were pushing otherwise? Is it just a desire to push a bit extra on exports?

The problem with the exchange rates is that impact does not stop with minor things like how much your widget will cost in the international market. Instead, exchange rates tend to have long term impact on the economy of a country, which extends far beyond whether tourists find it cheap to visit a country. It is worthwhile to examine some cases where a country neglected this aspect, which came back to haunt them later.

Perils of Too Much Wealth or a Spanish Problem
Columbus not only discovered America, but he also suddenly put Spain on to a seemingly endless path to wealth and power. The conquistadors found new land, and also stumbled upon probably the greatest horde of gold the old world had seen till then. All of that wealth funneled back to Spain, making the country fabulously wealthy for a while.

Over the following two centuries, the gold was used to build up Spanish military power and at one time, Spanish armies were marching across much of Europe. Spanish monarchy used the immense wealth and the power it projected to spread its version of orthodox Christianity, culminating in institutions like the Spanish Inquisition.

There was a downside to all this wealth too. As a result of all the gold backing up the currency (or gold being the currency), Spain ended up with a relatively expensive currency. In terms of relative prices, a unit of gold in Spain would buy far less than it would buy in England (which had relatively puny gold reserves, depressing local prices). In effect, Spain ran probably the longest experiment with an overpriced currency in the global economy.

The results were not pretty. The industrial revolution that transformed Europe effectively passed Spain by in its first wave. The country that benefited the most, no surprises for guessing this, was England, whose puny gold reserves at the start kept its currency undervalued over a fairly long period of time. For Spain, effects were devastating. As the free flow of gold from the Americas ceased, the impoverished nature of the economy came forth and lasted for a long period of time.

The reasons are not hard to understand. Short term mispricing of currency can pass without any serious damage to the economy. But long term mispricing can play havoc. Not only 'export oriented' industries suffer, but local industry has to face a good amount of unfair competition from cheap imports. Staying out of the market for extended periods, not being able to build up a wealth of capital and productive capacity, not being able to develop necessary skills and human capital for a long time; all these factors contribute to an effective destruction of local industry. There is a good reason why governments provide subsidies to build up their local industries. Such subsidies are designed (or supposed) to build up infrastructure, bring the industry to scale, build a wealth of knowledge and experience, and create sustainable advantages that last in the long run. The subsidy is supposed to go in a short period, but the effects are supposed to last for a long time. An underpriced currency also achieves the same thing, a de facto subside. By this logic, an overpriced one does exactly the opposite, subsidizes imports at the cost of local industry. And its effects too are likely to last for a long time.

Good as Gold
Gold has served as a dependable currency over a long period of time in the history of civilization, sometimes directly and sometimes indirectly (such as through the gold standard). Countries did abandon the gold standard at times, when the governments simply did not have the necessary resources to support the standard. But results were usually problematic (though not due to delinking gold from the value of currency). The standard dictated that there was a limit to printing money. Without the standard, governments printed money with abandon, often to disastrous results. The hyper-inflation that ensued in Germany during the Weimar Republic, for instance, saw a trillion-mark note being printed at one time.

But the gold standard has not been very productive either. Consider the Great Depression. An empirical analysis suggests that the restrictive monetary policy forced by the gold standard did contribute to the event and its duration. Countries eventually did abandon the gold standard during the depression, though different countries did it at different times. The interesting part is that there is a direct correlation between when a country abandoned the gold standard and when it came out of depression.

Currency purists would point out that currency devaluations are ultimately a zero sum game. If everyone devalues by the same amount, you end up in the same spot; with a lot of inflation (due to printing of extra money) and its bitter aftertaste. This is not what I am arguing for. My contention is different, all else being equal, if you continue to have a currency that is not moving in line with the economic fundamentals, results can be both bad and long term in nature. Nothing more, nothing less.

Coveting a Strong Currency
Notwithstanding this, many countries have coveted a strong currency, particularly if they don't have to worry too much about competitiveness. Also, countries with high level of 'pass through' (i.e., imports and exports being large percentages of GDP, with low local value add) tend to benefit from strong currencies. An example is Singapore, where low taxes and good infrastructure acts an allure for a lot of 'entrepot' or pass through trade. Since the local value add is relatively low, the strong currency does not act as a deterrent. Rather, the low inflation and stability brought in by a strong currency acts in favor of the country through strong capital flows and investments.

The US has followed a 'strong dollar policy' for a fairly long period of time. The reasons are not hard to guess. Moving mainly to a services economy, running a negative savings rate and needing a lot of foreign capital to plug its deficit, the US did need a strong dollar. It also got the benefit of being the world's reserve currency and needed to preserve the status (which a weak currency would have underminded). But the impact on the real economy was still pretty much the same. Manufacturing moved out of the US, first to Japan, then to Korea and Taiwan, finally moving towards China.

The interesting part is that the Bush years saw a quiet burial of the policy (though it was never officially announced). Large deficits, twin wars forced a lot of new money supply into the system. It had its unintended consequences through excesses committed (that led to the financial crisis). But another unintended consequence has been that now US manufacturing has started looking competitive again. Apparently, there was enough productive capacity in the economy to absorb all the extra money supply, hence the low inflation.

Other than strategic reasons, some countries do want strong currencies, 'national pride' being one of the reasons. But it has its price. For decades, Soviet Union managed an overvalued currency and kept the ruble slightly ahead of the US dollar. The real value of the currency was probably 1/10th of that level. Though it did not cause the complete collapse of the Soviet economy, but the fact that it had to supply huge amount of resources to its allies around the world at prices far below the cost of production would not have exactly enriched the economy.

India's Situation
Viewed in this light, the slide of the rupee does not look so bad. India has historically run high inflation, far in excess of global levels. Hence, to keep the local value-add cost competitive, the currency needs to depreciate by an equal amount. If that does not happen, the local industry and services effectively price themselves out of the market. Wages and other costs rise with inflation and then some more (real wages tend to increase with economic growth). While the 'real' part of wage increases needs to be managed through productivity gains, the inflation part must be adjusted through the exchange rates.

Is India Overpriced?
Looking at just the inflation differential parameter, here are some numbers. Between 1994 (effectively the time when the current account convertibility took hold) and 2004; the rupee gained about 20% against its trade weighted basket after accounting for the inflation differential with the world economy. China, which devalued its currency in 1994 (hence, the currency already started with a low base), fell further by 21% over the 10-year period. Effectively, there was roughly a 40% gap over this period between the two currencies.

The more interesting part is that the rupee gained in value from then on and appreciated by a good 20% by 2007. The Yuan/Renminbi also appreciated, but by then China had been hugely undervalued and local inflation was practically in line with global inflation. The rise of the Yuan meant that China allowed some of the undervaluation to be corrected.

Is India priced competitively with China today? I do not think so. Though there are 'economists' who keep pointing out that "Indian rupee has devalued by X% against the RMB since 2007". Well, first of all, you don't take artificially low bases for making such comparisons. Two, if you look at the long term currency values, the rupee has depreciated barely by 15% of its 2002-2004 trough against the dollar (48.50). At the same time, the country has experienced double digit inflation in CPI terms for most of the years since then. Even if our inflation differential was 3-4% against the global economy; the depreciation still does not offset the inflation impact even at current levels. In reality, we have run a hugely overvalued currency, particularly against our key manufacturing competitor, right up to 2011.

Manufacturing Prowess
Impact on India's manufacturing sector has been mixed. We have lost many battles to China in the process. The entire chemical manufacturing base of Indian pharmaceutical industry has shifted to China, with only some downstream operations and pill punching being done in India. Cheap Chinese toys, firecrackers and what not have killed Indian industries. Textiles, a huge employment generator, is virtually comatose, while countries like Bangladesh are emerging as the next big exporters after China's local wage rises have made them expensive. Even areas where high levels of expertise are required have seen a shift towards China. Thus, power equipment heavy weights like BHEL have lost to their Chinese competitors for building up the Indian power sector.

These are not 'export oriented' industries we are talking about. We are talking about hard core manufacturing for building up the country. If we cannot support this, whatever industrial base we have built up so far may wither.

Why are We Doing This?

The question then is, what have we gained from this all? National pride? Some ad jingles that pompously predict "one rupee equal to 45 dollars"? What truly confounds is the fact that no one has bothered to argue against this policy till date, even those for whom it has proven disastrous. More surprising still, even the exporters who directly gain from a lower rupee heave a sigh of relief when a weakening trend reverses and brings the currency back up. There is an army of 'analysts' and 'economists', which starts howling the moment there is any significant weakening of the currency. The picture painted is that of disaster and the country going to the dogs.

It is wrong to pin the blame on collective ignorance, mania or even national pride. There are underlying forces at work that have brought this to pass. The key questions are short term gains vs long term health of the economy, gain for the few vs gains for the many and finally, how the incentives in the system are aligned. We will try and untangle this knot in the next episode.

Where Else Will the Money Go?

noreply@blogger.com (Neeraj M) — Sat, 23 Jun 2012 18:24:00 +0000

Episode 2 - Of Paralyses and Deadlocks
This 21-part series (excluding the prologue and the epilogue) examines the challenges facing India and the economic headwinds. The title of the series comes from the book Breakout Nations by Ruchir Sharma, from a nouveau riche kid in New Delhi quoted by him. The quote captures the confidence, almost arrogance, that India has built up during the last decade, which is not limited to rich brats and extends to business tycoons, policy makers and politicians alike. The series tries to separate the myth from the fact, and examines some hard choices the country will have to make over next few years.

The world is justifiably angry with the European leadership for dithering on the crisis facing the Eurozone and taking only piecemeal measures. A couple of weeks back, some wires even termed it 'policy paralysis' in news items, a phrase we are familiar with.

Europe may have a policy paralysis, but it is of a different kind. At the heart of the issue is the question, should a diligent and prosperous neighbor bear the burden of profligacy of the guy next door? It may look necessary to the outsiders, and the one who needs the bailout may scream like a sacrificial lamb, but is it so easy to bear the burden?

The Germans view the problems of South in this light. They believe they are working harder than the Southerners (which is a myth), are more diligent in managing their finances (which is true) and should not be forced to bear the burden of others' inefficiency. The reality is a bit more complex.

Why the Germans Love the Euro
Germany's competitiveness comes from many sources, some of which are not really the result of diligence. Eastern part of the country is still not at par with the West, the process of economic integration is still not complete. Unemployment is high, cost of living is still low and Germany has an 'Eastern Europe' in its own backyard. Germany has also gained from a depressed Euro and did get the benefit of a cheap currency (unlike the Deutsche Mark) to boost exports, with none of the fiscal evils that would ensue had they tried to artificially cheapen their currency. 'Weaker states' kept the overall currency competitive, and the Germans did not have to live with the costly currency their levels of productivity would have demanded. The 'weaker states', on the other hand, lived with a currency that was costlier than their productivity levels would have permitted. The German export machine has prospered, while the rest has been laden with the need to make real adjustments in their economies. As an integrated market boosted trade in the Eurozone and made market access easy, German industry gained from both within and outside the Eurozone.

Today, you find the Germans preaching from the pulpit that Germany has created its competitiveness through the long and painful process of productivity improvement. This is, of course, true. Germany has real strength in overall productivity, technology and industrial processes. But they have also been aided by the Euro significantly, the costs of which have been diffused to all the member countries. Had their philosophy and economic policy been such a great success, they would not have had a significantly poorer east in their own backyard after 20 years of 'integration'.

Hence, the dilemma for the Germans, they have gained a lot out of the Euro and keeping the mechanism afloat is in their interest. They may have borne 'disproportionate' burden over the years for the sake of keeping the currency intact, but it was certainly not of philanthropic interest. The only problem is that demands like Euro bonds extend too far. And from their own point of view, making ECB the lender of last resort is also too much to bear.

A Political Issue
The problems of Eurozone, therefore, are much more political than economic. The North wants to continue with an arrangement that has kept it competitive and thriving, the South wants a monetary regime that is more suited to a weaker public finance situation and lower productivity. Pundits point out that a monetary union without a fiscal union cannot work. But if that is the answer, you cannot stop at fiscal union alone. You have to allow free mobility of labor and other factors also. It cannot be just imposing strict budgetary controls that suit German tastes, a more potent version of the deficit targets and austerity agreements that is already being pushed. This is a problem that cannot be solved rationally, someone has to drop their agenda of artificially tight budgets (which would punish the weaker economies and push them towards economic gloom for at least a decade) or others have to suck up to being forced into those very consequences just because the consequences of dropping out of the single currency are just too horrific. So far, the latter outcome is winning, as the Greeks have blinked and the Spanish have capitulated. The test will be when Italy (and later, possibly France) also gets pushed towards the same situation. Till then, I expect the deadlock to continue.

The implications for the global economy are serious. The Euro has been jeered at, it has been called impractical and all sorts of things. But the currency has found its place in the global financial system. Over the years, it has steadily emerged as a viable alternative to the US Dollar as the reserve currency of the world, something that gives Europe tremendous clout in the political and economic world. The fact that an economy with $15 trillion plus GDP, a tight monetary policy and strong currency vying for the reserve currency status can turn out to be a bad bet for investors is not something easy to digest.

The Indian Parallels
On more familiar grounds, policy paralysis is a term that is quoted almost daily. People have found different ways to express their frustration about it. Thus, terms like governance deficit, leaderless country and so on have found their place in the public discussion. But, is India's policy paralysis and political deadlock comparable to Europe? Is Merkel's refusal to consider Eurobonds similar to Mamata's refusal to allow FDI in retail? Can Hollande's populism be compared to antics of team Anna?

The problem with the scene in India is that almost all the rhetoric is based on random whims and poor policy. Merkel's opposition to Eurobonds is grounded in sound economic policy (from Germany's point of view) and national interest. Can we say the same thing about Mamata's opposition to retail FDI? Is it grounded in sound economic policy for Bengal or the state's (or national) interest? Hollande at least had some grain of truth in his policy pronouncements, that Euro zone will have to return focus on growth if the common currency has to survive in the long run. Dose any of Hazare's policy prescriptions come even close to solving the problems we have today? Appointing another layer of bureaucracy on top of existing one is hardly likely to cut corruption. While Mamata's work brought policy making at the top to a complete halt, Mr. Hazare's has managed to bring the same level of paralysis down to the bottom, with no one in the bureaucratic chain willing to take a decision.

Who is the Gainer?
The best part about the situation in India is that it is not in any one's interest. In the European impasse, something substantial is at stake for everyone. What is at stake for the regional satraps in India when they indulge in their fancies? And what is at stake for a ragtag group of people, who have no policy experience whatsoever, when they shoot their mouths off on everything related to public policy?

As of today, the industry is not happy, investors are not happy, and above all, people are not happy. It is really hard to understand how a situation that makes everyone really unhappy is impossible to resolve. A frozen leadership is a contributor to this, but it has gotten ample support from other quarters.

Are We Better Off than Europe?
If yes, how? We continue to believe that the flow of money will reverse miraculously as we are the dream economy. No matter how many times we shoot ourselves in the foot, global economic tide will turn, lifting our boat again. But we need to seriously ask ourselves, if Europe is being pummeled by investors for being high on paralysis, where is ours going to take us?

Where Else Will the Money Go?

noreply@blogger.com (Neeraj M) — Thu, 21 Jun 2012 07:14:00 +0000

Episode 1 - A Tale of Two BBBs...
This 21-part series (excluding the prologue and the epilogue) examines the challenges facing India and the economic headwinds. The title of the series comes from the book Breakout Nations by Ruchir Sharma, from a nouveau riche kid in New Delhi quoted by him. The quote captures the confidence, almost arrogance, that India has built up during the last decade, which is not limited to rich brats and extends to business tycoons, policy makers and politicians alike. The series tries to separate the myth from the fact, and examines some hard choices the country will have to make over next few years.

For several years, we have been denying that we have a problem. We can look at the specific instances later, but what hurts us today has been known for a while (including the issue of corruption in infrastructure projects during the first term of Dr. Manmohan Singh). We have, instead, chosen to blame external forces for our problems and woes. Europe, and its travails, have been the favorite topic for everyone to discuss. It comes in handy for policy makers to avoid blame for inaction. It also provides some perverse satisfaction to people who think India shines by contrast (we do not). But there are critical lessons being doled out for developing countries, which we are choosing not to learn.

It is useful to examine what is happening in probably the most concerning country situation in Europe today, Spain. Though Greece has been hogging the headlines for quite some time, I do not believe Greece is of a great consequence to Europe (other than for political reasons). The economy is tiny (Greece accounts for just 2% of Eurozone GDP). The debt level may look massive in comparison to the GDP of Greece, if the push comes to the shove, taking a hit of some 300 billion Euros is not a major problem for the Eurozone. The country mattered till it sparked fears of contagion, but beyond that, it does not have much relevance.

Spain, on the other hand, is of special interest to us. There are several striking parallels between what Spain is facing today and where India is. Both the countries are rated at a somewhat similar level by S&P, Spain has a BBB rating while India has a BBB- rating. The public debt to GDP ratio is also similar, Spain has 68% while India's estimates vary from 67% to 71% (depending on who you listen to). And above all, both the countries have the same level of GDP, $1.4 trillion.

Spain is getting a hammering from the markets that defies logic, at least in comparable terms. Spain today pays close to 7% (it went beyond that too for a brief period) on its 10-year bonds. India, in comparison pays around 8.25% (give or take 25 basis points for market fluctuations). But Eurozone inflation is a comfortable 2.5 - 3%, while India has been boiling over with 7%+ in WPI terms and 10%+ in CPI terms. Even if take WPI as the benchmark, as per the latest numbers, India is paying less than 1% in real terms on its bonds, while Spain is paying more than 4%.

The explanations behind this seem logical. There are concerns about Spain's ability to service its debts and the yields have shot up. Market estimates that Spain will have to pump in more money into its banking system and the debt levels will peak out at around 90% of the GDP. That is too high, according to the market wisdom. Or is it?

You might want to ask what Japan's debt to GDP ratio is, since the country has experienced practically no growth or very low growth for about 20 years now, and yet pays less than 1% on its 10-year bonds. Does it explain Spain's situation? No, it does not. People cite lack of control over monetary policy as the reason behind Spain's problems. Yet, there have been numerous countries that have pegged their currencies to stronger currencies time and again (usually dollar). Do their dollar borrowing rates climb to such levels, even though they lose control of their monetary policy as a result? There are issues that Spain is facing today, but the more you examine them in depth and ask the question 'why', the more intriguing it gets.

Now, coming to India, how is India getting away with paying a much lower effective yield (or even a negative one, if you base the computation on the CPI) when its finances are not in a better shape than Spain? The belief that India is better in terms of public finances is not backed by evidence (compare the budget deficit of both the countries). To believe Spain has a bigger debt problems is also not supported (both the countries have similar debt levels). Even Spain's banking system may not have bigger issues than India. Spain's bad loan percentage is about 8.7% according to latest numbers. India is well below 3% today, but you have to consider the liberal rounds of CDR the banks have been doing to avoid classifying loans as NPAs. With the entire infrastructure sector under water, it is hard to believe that banks would be able to recover money lent to power companies, BOT companies, real estate companies or construction companies any time soon. Spain has a consumer level debt problem, where home buyers cannot service the debt. In India, problems reside in a trickier place, the sellers have borrowed too much and they cannot service their debt.

This is not to argue that both the countries are absolutely similar and India will necessarily have the same problems. Though the economies of both the countries are of the same size, their per capita income is not. At $32,000+, Spain has a per capita income more than 20 times that of India. India obviously has a lot of pent up demand that can drive growth with relatively little effort. There are other important differences too that would have a bearing on the outcome.

The comparison raises disturbing possibilities for India, that is why it is important. We have been assuming that India has a much higher growth trajectory and we will be able to service our debt. So long as that condition continues to be true, we might be safe. But is that condition necessarily true? And why is Spain being hammered in the markets like this to begin with? These questions might help us understand what the Indian growth scenario will look like over next two years or so.

Where Else Will the Money Go?

noreply@blogger.com (Neeraj M) — Sun, 17 Jun 2012 11:51:00 +0000

Prologue
This 21-part series (excluding the prologue and the epilogue) examines the challenges facing India and the economic headwinds. The title of the series comes from the book Breakout Nations by Ruchir Sharma, from a nouveau riche kid in New Delhi quoted by him. The quote captures the confidence, almost arrogance, that India has built up during the last decade, which is not limited to rich brats and extends to business tycoons, policy makers and politicians alike. The series tries to separate the myth from the fact, and examines some hard choices the country will have to make over next few years.

Through the better part of the last decade, India seemingly came into its own. The country developed a certain sense of pride. Unlike the stark days of the 80's and 90's, people did not fear ridicule if they said they loved the country. Foreigners flocked here, ever smiling and doling out flattering views on the country to people who were seeking and absorbing a vast amount of reassurance. In general, we tried to develop a sense of confidence in what we are and what we wanted to be.

The new found confidence, unfortunately, spelt a death knell for reforms. The global liquidity tide lifted India well above its earlier growth trend line, and it meant a complete end to the will to do anything meaningful to address the massive problems besetting India. Instead, those who could get away with it, found a new license to loot the country in innovative ways. From telecom licenses to hosting games, the ugly structural underbelly got exposed a tad bit late.

Today, the mood is a bit somber. Some are a bit incredulous that India is slipping back. Some are in denial. We are finding it hard to accept that the new assumptions about India that took hold in the last decade are fading.

Denial won't do. Nor will random policy prescriptions. "Cut rates", "don't cut rates". "Give more stimulus", "don't give stimulus". "Inflation is a problem", "inflation is not a problem". "Debt is too high", "debt is not too high". "India shines by comparison", "India has grave problems". The cacophony of voices goes on and on. Underlying these voices is a mix of several contrasting undercurrents; the sudden alarm you feel when a horrifying bit of vulnerability comes to your notice, the promise India holds and the betrayal of that promise, the hope that somehow it will all work out, and the despair of having a divided polity, a comatose government and no clear sense of where we are heading.

"Where else will the money go?" will try and look at some stark facts below the surface and examine many of the assumptions we have come to regard as sacrosanct and as the given truth. "We are one of the few choices investors have globally, India will always grow at 7% or more, India's troubles are caused by Europe, the rest of the world is in far deeper trouble than India"; these are some of the assumptions that are quoted by those who want to put a positive spin on things. Equally problematic are the assumptions we continue to hold about role of growth in uplifting people out of poverty, the redistributive agenda that rules our thinking and the how horribly we underestimate the forces that have kept India in the shadows of the world over past two and a half centuries. Once you sort through the mess, you would probably come to recognize not all is rosy, but also conclude there is a silver lining to the clouds, a light at the end of the tunnel.

Hope you enjoy reading it.

Long Grind Ahead

noreply@blogger.com (Neeraj M) — Wed, 02 May 2012 05:50:00 +0000

The sentiment post the budget has turned out to be a lot more negative than was anticipated at the time of the previous post. ‘Policy paralysis’ has become talk of the town. GAAR has everyone fuming (notwithstanding the fact that it was always part of the plan, as part of the long awaited DTC, which, ironically, is part of the reform agenda). These are not surprising things. When the economy is roaring and everyone sees money being made everywhere, even dumb policy things seem quite palatable (remember the fringe benefit tax?). And when things are not looking as nice, even reasonable questions look like nit-picking.

Take GAAR for example. Which government in the world is not going after ‘tax havens’? Be it the US or the UK, tax laws are tightening to prevent leakages. And what is so wrong if the ‘Mauritius route’ to money gets closed? For FIIs, the impact is going to be zero if they hold shares for one year and sell through a stock exchange. Even if they sell before a year, the 15% they pay is nowhere near exorbitant.

The critical point is, the country is becoming unattractive to the investors as a whole due to a slew of issues. Policy paralysis is being talked about today, but policy was always paralyzed under the UPA regime. I don’t think anyone can name even one big reform under the stewardship of Dr. Manmohan Singh as Prime Minister. So long as things were humming along nicely, everyone was happy with the paralyzed the government.

This is not to say the government is not to blame. Over past two years, the clock has indeed been turned back on the economy, and by a long measure too. We now have the redistributive agenda on top with MNREGA as the policy poster child of the government, fertilizer/fuel subsidies as the favorite way to spend money and corruption/cronyism as a preferred way to run the administration. This is quite a setback for a country that had learnt to take pride in itself only recently, over barely a dozen years.

The fact that it has coincided with global sentiment not being so sanguine only makes it worse. It means getting back from this spot is going to be difficult, with no global safety nets, no windfalls from a roaring capital flows gravy train, no respite from commodity prices that buoyed the 1^st term of the current regime. The negative economic trends that have been unleashed in India will take some time to play out and even more time to reverse. Take inflation for example, the current bout which is hardly over is typical ‘demand led’ phase, which was fueled by copious liquidity. Soon, we will move to a ‘cost push’ as high input prices start getting passed on to buyers everywhere and then some more as expectations of future inflation would reset to a new level. Then follows the ‘wage-push inflation’, as high cost of living forces the workforce across the board to demand some compensation. Those who believe inflation is going to be tamed soon need not wait for too long to see what is in store. We just need to wait for MSPs for agri-products for this year to see when ‘cost push’ starts kicking in.

Coming back to the sentiment, issues like GAAR are the added "bad taste in the mouth" when you suddenly realize that you pumped in too much money in a mediocre growth scenario and it may take a while for you to get out. Just the act of trying to take it out is likely to lead to major losses for investors.

When the government is bent upon taking the country back to ‘same old’ and there is no hope of your fundamental growth assumptions to be realized, anything and everything looks irritating. That, in short, characterizes the mood you are seeing in the market.

So why are people not talking about this souring of ‘India growth story’? Partly, they have begun to. Those who don’t have too much at stake will probably start getting more vocal about it. Those who have a lot to lose will probably not want to profess their views openly and create a rotten mood all around.

But make no mistake, there is a long road ahead if you are looking towards 9% growth...

Precipice Ahoy!

noreply@blogger.com (Neeraj M) — Thu, 23 Feb 2012 16:46:00 +0000

The fundamentals of the economy paint a nice picture of where we are headed in the immediate future. Though the 7.1% growth estimate (by PMEAC) for FY12 takes us above our comfort threshold and many would have heaved a sigh of relief, projection for the next year comes with a list of contingencies attached to it. This is not surprising at all.

A quick look at a few statistics reveals where we are headed. Despite boasting a high rate of growth over past several years, India is one of the few economies globally that still posts a 10%+ rate of unemployment, which means there is a meaningful section of the economy that is not getting any benefit from the growth. Farm sector still accounts for 50% jobs in India. This sector has not benefitted from either growth or from global commodity price boom (due to policies that don’t allow farmers to move produce from one state to the other, let alone export it). With extent of poverty not declining and inflation eating away at the purchasing power of a significant section of the population, the Indian consumption story is seriously at risk.

The rest of the story is equally depressing. We have ongoing stalemate in many sectors which are critical to growth. This includes power, where the government coal monopoly cannot get its supply act together. Growth being a power intensive business, it is bound to have repercussions. Infrastructure continues to be in doldrums, despite fancy numbers like $1 trillion being thrown around. Telecom, aviation, textiles, capital goods, consumer durables…, the story is not very encouraging.

If we start adding the center and state’s fiscal woes to it, we get a fairly bleak picture of it all. The point is, how did we manage to dig ourselves into such a hole despite almost a decade of growth, and despite a global economy that has been essentially benign (though the financial crisis did look like dampening growth, the liquidity flood that ensued more than offset the disadvantage). Even today, if you ask yourself the question, what is it in the external environment that creates a big threat to Indian growth, I am sure you will struggle for a cogent answer. The best we can do is probably ‘high oil prices’. Unlike the rest of Asia, we are not export dependent to keep the growth engine humming. If we had our house in order, there is nothing in the environment to derail the economy.

The truth of the matter is, most of our problems are of our own making. Fiscal mismanagement means we have allowed inflation to get out of control (though the global flood of money has played its role) and it is seriously hurting. Large fiscal deficits always hold monetary policy hostage. Either the government prints money for filling the gap (which would be inflationary), or the central bank has to keep the system flooded with money to allow the government to borrow at reasonable rates. The same goes for the oil mess. The government never bothered to decontrol prices when oil prices were low (the government was making a good surplus out of it, of course). Now it is politically unacceptable to raise petroleum product prices. The same applies to other areas where subsidies are hurting. If you start adding policy paralysis, corruption scandals, fractious politics, etc., to the mix, it is wonderful recipe for concentrating the mind.

The outcome is a situation where everyone is hurting and everyone is looking to the government to sort out this mess. There are high hopes from the budget. Almost every sector is hoping for a duty cut, and almost everyone is looking for a dollop. It is anyone’s guess where these hopefuls are likely to end up.

The current stock market boom is probably a combination of copious amounts of money and some wishful thinking. This may continue till the budget comes out. Chances are the budget will try to make everyone happy and end up pleasing none. Going by the track record of past 8 years, it is not likely that someone will stand up and say, ‘we need to make some hard choices, and we will throw everything behind these three (or four or whatever number you prefer) top priorities’.

In absence of any real measures taken to put the economy on the growth path, stock market is likely to see the reality quickly enough. The current levels may be sustained till the budget day, but reality is likely to sink in fairly quickly post budget (if it does not happen before then). A surprise may be in waiting for those banking on wishful thinking to continue the good run.

Riding on Fizz...

noreply@blogger.com (Neeraj M) — Tue, 21 Feb 2012 17:00:00 +0000

Indian stock market has outperformed practically every other market in the world in 2012. This is not very surprising. India was among the worst performing markets in 2011 and relief rally has seen many beaten sectors/stocks recover some of the lost ground.

The surprising part is the speed of the rally, failure of most of the big players to spot it well in time and the relative paucity of good explanations on why India is suddenly booming. Most of the people I speak to are just dumbfounded. Barely 8 weeks ago, the India story had gone bust, the infrastructure sector had caved in, power plants did not have fuel, policy didn’t have direction and government didn’t have the tenacity needed to stand up and deliver. The question is, what has changed in a month or two?

The sad part is, nothing. Fundamentally, we are exactly where we used to be. To the extent that behind the veneer of a booming stock market and a massive inflow of portfolio dollars, even the liquidity situation is as tight as November, prompting hints from the RBI on another CRR cut. Falling car sales, slowing tractor and durable goods sales in the rural sector, ballooning real estate inventory; all the elements are the same as before.

This leaves few explanations for the ongoing rally. One of the plausible few is the fresh glut of liquidity in the wake of the Greece crisis. Equities worldwide have gone up as a result and India has received a good chunk of the money. The precipitous fall of the rupee last year provided an added incentive. Strong defense of the currency by RBI and past experience would have convinced many that rupee weakness was unlikely to last for a long time. Stocks looking doubly cheap on a dollar basis would have added to the temptation. Indeed, if you invested in dollar terms in December, you would have already made a 16% on the stocks and another 16 on the currency, quite an unbeatable package.

But where do we go from here? The answer is not very clear. Once again, my bet is on commodities. Stock markets across the world may be rising, but their ability to absorb the excess liquidity is going to be limited due to poor fundamentals. Bond yields are also likely to continue to stay low globally (and high in India, more on that later). It is very likely that a good chunk of liquidity will flood commodities, causing an upward spiral all over again.

This does not augur well for the Indian market. High commodity prices, particularly oil, will further worsen the fundamentals. Coupled with Government’s inability to implement policy reforms (we have not even been able to sort out whether luxury cars should get a fat diesel subsidy or should finally bear the cost of fiscal and environmental damage they do), this will only worsen the pressures the economy is facing. The market is currently riding on fizz and it is hard to tell how long the fizz will last.

Government Debt and the Role of RBI… Back to the Future?

noreply@blogger.com (Neeraj M) — Mon, 20 Feb 2012 13:10:00 +0000

Governor D Subbarao’s musings about government debt and need for a cap on borrowing hark back to an era that we have almost forgotten in India. Not so long ago (say, till late 1990s), the primary role RBI played in balancing monetary policy was managing the government’s borrowing needs against the monetary needs of the economy.

Government borrowing in India has historically crowded out the private sector, there is nothing new about it. Till late 1990s, the traditional monetary policy tools were more or less ineffective due to this. For the banking sector, the primary tool RBI deployed was 90 and 180 day T-bills. Banks were more or less relying on their T-bill purchases to meet their reserve requirements on every reporting Friday. The catch? RBI used to measure their reserve adequacy only on reporting Fridays and the bills could be discounted freely by the banks. The highlight of this policy setting was that more than 99% of the T-bills bought by banks were discounted the following Monday. In essence, banks were keeping their funds in T-bills for only a few hours over the entire fortnight for which the reserves supposed to be maintained.

Bank rate, similarly, continued to be totally ineffective tool for a long period of time. Banks could technically borrow from RBI at the bank rate, but only to the extent of a small fraction of their incremental deposits, in effect making the bank rate practically useless for managing monetary policy or interest rates in the economy.

This situation prevailed primarily because the RBI was tasked with managing government’s debt requirements. Thus, whatever deposits the banks raised, a large chunk of that went into government bonds as the SLR component. In a cash starved economy, it meant that there was little liquidity left in the system for the private sector and banks. The result, a farcical situation in which banks needed to game the system to meet the liquidity needs and RBI did not have choice but to turn a blind eye to it.

The situation changed dramatically in the 2000’s. Falling fiscal deficit, rising growth rates and flood of global money meant that India was suddenly had a deluge of liquidity. Private sector could access capital internationally at far more competitive rates. Liquidity started chasing yields, which meant government bonds became attractive and banks started keeping more money in gilts than SLR required. With this flexibility, RBI, perhaps for the first time, gained true control of monetary policy and its tools gained a true bite.

All this can change dramatically again, if the government allows the current fiscal mess to continue and its borrowing needs start crowding out the private sector. And many signs are pointing in that direction. International money is no longer flooding India the way it was in the middle of the decade, borrowing internationally is becoming more difficult and costly, and RBI is forced to tighten domestic liquidity due to inflation concerns. Though the situation has eased somewhat with January inflow of portfolio dollars, it is the only source of liquidity at the moment and its drying up could suddenly lead to a drought of money.

In this situation, RBI could find itself in the same dilemma again. In a tight liquidity situation, government borrowing will start crowding out the private sector. Interest rates, in that case, would be driven more by the ‘going rate’, rather than tightly controlled by the RBI. Hence, the comment by the governor assumes significance.

What does it mean for the markets? One key factor to keep in mind is that if liquidity starts drying up again, the assumption that interest rates will fall no longer holds true. RBI will be hard pressed to inject liquidity into the system but will be constrained by inflation rearing its head again. Token rates may fall, but with no money available at those rates, private sector will be forced to borrow at whatever rates money is available. Not a great situation when most of the sectors are reeling under less than stellar outlook and growth has started hurting. The only hope lies in the government being able to manage its finances better and letting the economy be.

Rising Support for Yuan as a Reserve Currency

noreply@blogger.com (Neeraj M) — Sat, 26 Jun 2010 16:01:00 +0000

CHINA VS. INDIA

More than one year ago, I had written on this blog regarding the global ambitions of China; in particular its push to get Yuan accepted as international reserve currency (Of Triffin's Dilemma and China's Ambition , April 6, 2009). Since then, things have moved slowly, but almost surely in favor of this move. The latest voice to be added to this growing 'movement' is that of Asian Development Bank, which released a report this Thursday suggesting Yuan 'has the potential' to become an alternative to the US dollar (Yuan can become alternative reserve currency to US dollar-ADB).

At this point, it is not known how long it will take for the Yuan to "internationalize". That is irrelevant. What matters is the reality of China becoming more and more important in the international financial system and its implications.

China has emerged as a stabilizing force over past 18 months in the aftermath of the global financial crisis. It has done favors and most likely would have been promised rewards in return. Furthermore, China's continued cooperation is important for the world to avoid lurching back into the deep, black hole that was barely missed about 18 months ago. In other words, the timing is just right for the dragon to stake its claim to its rightful place in the world.

That brings us to the next question: what is dragon's rightful place in the world? That question gets answers as diverse as the 'color depth numbers' on the latest LED TV models; right across the spectrum. There are those who just can't stop loving China, staking everything on its economic juggernaut. There are those who just can't help being skeptics. Then there is the newer, emerging view that China is just like Japan in the late '80s; overrated, but just a spent force about to go belly up.

Truth is likely to stranger than all these punts. Punts they are because it is hard to know China despite all those 'research dollars' being thrown at it by consulting firms, investment banks and brokerage houses, trying to make sense of the puzzle that China is. Instead of relying on these 'house views' and 'in-depth studies', it is better to simply look at the growth curve of country and something rather simple: human behavior.

And the human behavior dictates that the internal consumption story in China has not even woken up yet to its full potential. Per capita GDP numbers hide a vast gulf of disparity between China's elite and its have nots. The have nots have kept quiet so far due to the ability of the system to deliver and the system has been delivering. Why should they put their faith in anything else? As soon as their turn comes, an army of consumers will rise. There is nothing to stop them.

There is a historical precedent to it as well. Much to the chagrin of purists, the US of A provides the prime example of an economy in transformation; exactly one hundred years ago. The economy had just been finding its feet after a 50-year growth run with per capita incomes of about $5000 in today's terms (about $1000 higher than today's China, but then you can't be exact about this stuff). What happened after that is anybody's guess. Runaway growth, wild capitalism, rampant bull runs; only to be tempered by a Wall Street crash and global depression twenty years later.

Folks, the dragon has barely begun. More on this later.

Ciao. And apologies for disappearing for so long.

Why We Need a Stop Loss

noreply@blogger.com (Neeraj M) — Thu, 08 Apr 2010 06:23:00 +0000

TRADING PSYCHOLOGY

My favorite piece from Zen literature.

Master Caotang Qing said:

The fire that burns a meadow starts from a little flame, the river that erodes a mountain starts drop by drop. A little bit of water can be blocked by a load of earth, but when there is a lot of water it can uproot trees, dislodge boulders and wash away hills. A little bit of fire can be extinguished by a cup of water, but when there is a lot of fire, it burns cities, towns and mountain forests….

When people of old governed their minds, they stopped their thoughts before they came up… Therefore the energy they used was very little while the accomplishment they reaped was very great.

- Zen Lessons, translated by Thomas Cleary, Shambhala Books, Boston

I don't think I can say it any better than the Master said. So I will just shut my trap and let you meditate on it.

Confirmation pouring in: We are in the middle of a commodities boom and a dollar flood

noreply@blogger.com (Neeraj M) — Tue, 06 Apr 2010 07:33:00 +0000

GLOBAL ECONOMY; GLOBAL MARKETS

I did not expect confirmation of my yesterday's views so early. Of late, confirmation has generally been arriving pretty soon for what I have been observing. On NIFTY breakthrough (Violent and Brief), it took the market barely one day to cross the long held resistance.

There is sporadic evidence emerging for the hypotheses I proposed yesterday (Recovery : Final Confirmation, Twin Deficits and Rising Inflation). Broadly, my argument is on the following lines.

Recovery in the West has been underway for some time and now we are seeing final confirmation of the same.
At the same time, this confirmation is of little use, mainly because what brought the recovery is going to be a massive drag from here on.
The large US budget deficit is also going to create a massive trade deficit. This means:
- Higher purchases of US treasuries by foreign governments; this will fail to absorb the entire trade deficit.
- Additional dollar supply flooding the market; since there is no penalty for the US for letting the world slosh in its money. Exactly one year ago, I was ranting about the same thing and why China and even EU want piece of the action (Of Triffin's Dilemma and China's Ambition). It is funny how an old rant can seem new sometimes.
- Commodities on fire; the dollar flood is going to simply push commodity prices out of the stratosphere.

A cursory glance at Bloomberg page today brings the following news.

Rise in Treasury Yields Slowed as Currency Reserves Grow Fastest Since '08

Oil Surges to 17-Month High on Signs of U.S. Economic Growth

Copper Advances to Highest Level Since August 2008 on Recovery

Financial journalism tends to put a spin on everything. Right now the spin is 'recovery'. Well, there is another explanation that is far simpler; dollar flood. And then there is the Euro flood that is almost as big. And then, there is the Pound flood that is the biggest of all in relative terms (just measure the relative sizes of the budget deficits to the economies). The "gainers" of this not-so-hard earned money, on the other side, are also easy to identify. Export powerhouses like China (who incidentally refuses to let the currency appreciate) and commodity dependent economies. Japanese yen is around 93 (you can bet the Japanese are not very happy about it but will keep quiet because it will rise to probably sub-80 levels if they let it go free), Australian dollar is heading towards parity again and Brazilian Real is at 1.76. The evidence is all over the place.

To avoid confirmation bias, am still looking for that one bit of contradicting news which can disprove the hypotheses. If you come across something, please do throw it in.

Recovery : Final Confirmation, Twin Deficits and Rising Inflation

noreply@blogger.com (Neeraj M) — Mon, 05 Apr 2010 12:41:00 +0000

INDIAN MARKETS; GLOBAL MARKETS

Much has been made of the recent job growth numbers out of the US. They are a very positive sign of course. But what does it augur from markets' point of view?

Not very much, not at least from the US markets' perspective. Here is why. In any typical recovery, most of the indicators start registering a positive long before growth starts showing up in job numbers. As an indicator, growth in jobs is probably the one that lags the farthest behind. The reason is not difficult to see, no matter how rosy the outlook starts becoming, you will always want to check twice before you add those extra workers to your payroll. If you have any doubt, you will most likely opt for paying overtime or other such temporary measure.

Hence, the value of the indicator is in confirming that a recovery has actually taken place. Yes, it makes not a very convincing confirmation since the number has been positive only twice. But if you are waiting for further confirmation, you are already way behind the curve.

It does not augur necessarily well for the US stock markets. Much of the move has already happened and there are major challenges going forward. The toxic assets that caused the problem in the first place are still stuck somewhere in the system. The large stimulus, even though it drove the recovery, is going to be a major drag in the form of fiscal deficit in the US.

For emerging markets, there are many positives though, particularly for India. India came out of the shock with relatively little 'stimulus' and whatever has been provided has been rolled back. Fiscal position is looking good. Hence, the growth is solid. Furthermore, even financing crunch (due to lack of liquidity) is likely to ease, as explained below. All looks well for Indian market, except that inflation is going to be a complete pain.

Rising liquidity

Huge budget deficit in the US is going to drive a huge trade deficit too (they are two sides of an equation, no matter how much hot air US policy makers blow, there is no way you can eliminate one without eliminating the other). Which means the world is going to get inundated in dollars too. Whether you like it or not, a dollar flood with continuously falling interest rates is inevitable over next one year. Some of it will go back to the US as Central Banks buy US treasuries, some of it will simply be funded by excess money supply. Such is the prerogative of those supplying the reserve currency of the world.

Commodities again

No turning back the commodity inflation cycle from here. Once again, the rollicking days of ever rising commodity prices are here. That is likely to be the situation for next one year. If you bought some of those metal stocks here when they were going cheap, you are going to be rich pretty soon! Jokes apart, we are looking at a repeat of the late '70s here, nothing less.

Violent and Brief

noreply@blogger.com (Neeraj M) — Fri, 02 Apr 2010 17:09:00 +0000

INDIAN MARKET

So we did have a dip from the 5300 levels afterall (Waiting for the Breakthrough) on the NIFTY. Nothing very surprising there. The market has bounced back from its minor correction (if you want to call it that). We are back on the gates of the 'zone de résistance' and things might get stuck here again.

Or they might not. I do not know whether the bearish side of the market has had its fill of adventure or not. If not, we will see another skirmish. But at some stage (possibly in this very move), the zone is likely to be overrun.

And it is likely to be overrun in a big way. This is not the first time that this level is working as a major resistance. Post the Lehman dip, this level has alwathings might get stuck here again.

And it is likely to be overrun in a big way. This is not the first time that this level is working as a major resistance. Post the Lehman dip, this level has always held. It was not broken during the post election rally, held out once again against medium term trend and is proving tough to breach for the medium term trend move.

The strong resistance means that a break is likely to be fairly forceful and swift when it happens. There is a lot of pressure built up that is likely to be released when the breach comes. All the doubtful bulls sitting on the sidelines will jump in at the sight of a convincing breach and that will make the move quite sudden.

For those salivating at the thought of making a quick buck in the move, here is a sobering thought. Given that a large chunk of the market is now dominated by robo-trades, there is no way exact timing of the move can be predicted. Going aggressively long has its risks, as you can get caught in the 'sucker bet' downmove generated by automatic algorithms. At the same time, there is no telling when the market may make a sudden breakout. In all likelihood, it is going to be a very violent affair, and a very brief one. Given the nature of trading in the market, it may be over before you can say "gotcha!!!"

A Questioning Mind

noreply@blogger.com (Neeraj M) — Thu, 01 Apr 2010 08:46:00 +0000

TRADING PSYCHOLOGY

Yesterday's piece cited one recent piece of research that insists there are specific 'centers' in the brain that control temptation. Also, 'stimulating' those centers somehow seemed to alter the level of temptation subjects could bear. Does it mean we should snap electrodes to our heads to stimulate our brains before sitting down in front of the trading screens?

The answer to that brings us to another important trait that makes a successful trader, a questioning mind. On the face of it, the research seems innocuous and straight forward. But it might not be. There are too many give-aways. The first one is the intent to produce a 'drug' that can help you control temptation. I won't even get into the ethics of doing this. The other is the fact that there could be a much simpler explanation for the phenomenon observed. We all know (thanks to a movement that took this principle to the height of stupidity) that the right side of the pre-frontal cortex processes information holistically while the left side processes sequentially. So it is not hard to imagine that stimulating the 'holistic' side will help you thwart temptation while working the sequential, 'next step only' side will drive you right into its clutches.

This is too simplistic, of course. As simplistic as the right-brain left-brain movement, which incidentally made the assumption that 'using your right brain' was a simple matter of shutting down half of your brain (a truly "half-brained" approach). Let us not even get there. But the moot point is that you can avoid questioning 'given wisdom' only at your own peril.

The same applies to investing also. "Very well known" you would say, "tell us something new". Well, the new thing is that 'cultivating the questioning mind' is something different from what it is made out to be. What does not matter is how many questions you raise, because simply raising questions is not enough. What matters is what questions you are asking and what you are willing to accept as an answer.

The importance of asking the right questions and framing has been explored long ago by behavioural finance pioneers Tversky and Kahnemann. Those who are interested in the area would enjoy their brilliant work and how ingeniously they separated the motivations at work layer by layer. In most of the cases, path breaking conclusions look extremely simple in hindsight, though getting to those solutions to begin with might have been extremely hard (due to orthodoxy, 'given wisdom', etc.). The beauty of their work is that most of what they say is so counterintuitive that even today it never fails to startle. To come up with answers that are counterintuitive yet startlingly true, not only against the 'given wisdom' of the time, but still amaze three decades later requires a rare quality. A truly questioning mind.

More will follow.

Hard Wired Traders?

noreply@blogger.com (Neeraj M) — Wed, 31 Mar 2010 17:37:00 +0000

TRADING PSYCHOLOGY

There is some good news on the trading horizon. At last, you have a way to literally shock your brain into doing the right thing. All traders have known for ages what the right thing is; take your losses, sit on your profits, so on and so forth; but succumb to temptation.

New research indicates that "maturity" (or lack thereof) of the pre-frontal cortex is to blame for people falling to temptation (try this Yahoo link for the full story). This has fairly strong implications for people who want to become active traders or investors. It is no longer a matter of following some standard advice on 'taking your losses'. It boils down to whether you are wired or not for taking the high pressure situations this profession puts you into.

Ability to delay gratification or to withstand temptation is a core measure of maturity of a person. The trait is valuable across the board. It is the best predictor of future success at an early age. It can determine whether you live a healthy, well adjusted life or will indulge in self-destructive behavior. It is at the heart of decisions like whether to get up early in the morning to exercise, give up that next drink so that you can drive home safely or give up the dessert after dinner despite being presented with truly sinful but delicious option. It also has implications like whether you will diligently plan your finances or will run budget-busting credit card bills. But nowhere is this more visible than in investing and financial markets.

Trading and investing (I do not necessarily differentiate between the two, it is just the time horizon that separates a trade from an investment) definitely requires an ability to give up short term pleasure, even bear extreme pain (remember the last stop-loss that you took?) for long term gain. From start to finish, trading is all about sticking to the discipline of doing the right thing.

This advice has sounded very easy to follow. But real world stands testimony to how difficult it is to practice. Barely 1% of traders are profitable in the long run. The usual explanation for this has been 'trading talent', but it has remained elusive what this talent is all about. How do you differentiate who will be a good trader and who will wilt under the temptation of letting that loss-making trade run just a little bit longer in hope of salvaging something?

Surely, trading involves a lot more than just brutally enforcing your stop losses. It requires diligent research, a sharp and keen mind and a great run of luck. Still, some of us could use just a little bit more of that discipline to make the difference.

So where does this lead us? Shall we all wrap electrodes around our heads and start "stimulating" the correct regions of the brain? May be not so fast. More on that later.

A Strong Sense of Entitlement, or Something Else?

noreply@blogger.com (Neeraj M) — Tue, 30 Mar 2010 15:13:00 +0000

TRADING PSYCHOLOGY

Last week, there were two very interesting headlines Times of India's Delhi Edition had on its front page (of course, hidden behind the annoying half page of advertisement that simply kills the pleasure of picking up a paper in the morning). The first one was on the fire in a building in Kolkata. The story writer ranted on 'unapproved additions to the building', lack of safety norms and so on. The conclusion was that the civic authorities had failed completely in their duty.

This is not interesting on its own. The interesting part was the second story. Again, the writer ranted on cancellation of day one of fashion week in Delhi. The arguments were on the lines of authorities having been informed sufficiently in advance, people waiting in queue, authorities not getting their act together, etc. Buried somewhere in the story was the fact that the organizers were not able to meet all safety guidelines and that delayed approval.

So there you are. As a society, we are heading to a situation where we cannot tolerate even a minor disruption of what we want to have. We want our gratification, right away. Somebody else owes it to us and we will shamelessly lash out even when we are at fault for delay.

That attitude kills an investor or a trader more than anything else. In this game, there is nothing worse than getting into the ring (figuratively, now that everything is electronic) with a strong sense that the market owes it to you. Even a small dose of this poison can do irreparable harm to portfolios carefully nurtured over long periods of time.

For a trader, it is even more dangerous. You cannot blame market analysts, policy makers, the government, media or anyone for anything. The trader has to take responsibility for all that happens to her position. The trader cannot blame even the tools, so what if a tested technical pattern did not hold out on a particular day and you lose money? The market does not owe you anything, nor do Mr. Head and Shoulder, Mr. Double Bottom or Ms. Third Wave.

Why am I writing all this? Because after years of reminding ourselves over and over again, there still is a day when the stop losses get hit and we just cannot help cursing that analyst whose 'advice' provided that extra bit of justification needed for putting on a trade. You can laugh at them, berate them or otherwise disagree; but you cannot blame them. The blame lies squarely with you, the Trader.

Waiting for the Breakthrough

noreply@blogger.com (Neeraj M) — Mon, 29 Mar 2010 07:46:00 +0000

INDIAN MARKETS

The market is stuck at a strong barrier, the strong resistance of getting past a previous high in the recent past. The general prediction in the market seems to be that the resistance is too strong and this is the time to take profits. Is it really?

Let us consider the pure momentum argument. This market has had a lot thrown at it over past one month. High inflation in India, tightening stance by RBI, possibly higher interest rates, international risks (e.g., possible Greek meltdown) and so on. The result? The market barely blinked.

On top of that, we have had a sizeable portion of the market yelling that the market is ripe for a break and it is time to take profits. Still, the market has refused to break down.

Instead, the market has spent considerable time getting consolidated in each "resistance" range. And then breakouts have happened, very quick movement and then you get stuck again at the next "resistance".

All this means only one thing, the "resistance" is the last stand of the bearish crowd who have made tons of money in the past taking similar positions and are waiting for another repeat of the "same old thing".

I do not know whether this "repeat" will happen or the market will break through this time. I am completely agnostic to either. But given the strong amount of resistance at the moment, any break from here is going to probably pause only once (may be 5500?) before the last barrier is broken and the floodgates open. Once that happens, this market might not stop before revisiting its all time highs. Who knows?

Who is right?

noreply@blogger.com (Neeraj M) — Fri, 12 Mar 2010 10:15:00 +0000

GLOBAL MARKETS; INDIAN MARKETS

Globally, things are in a flux. There seems to be some consensus that the economy is on the path to recovery. Still, global economy is going through a lackluster phase and the net data flow is neutral at best. This is perhaps the best time to observe what predictions people make and how those predictions pan out (and most of them will end up doing something pretty "rude" to themselves, that is an almost foregone conclusion).

As usual, when things are finely balanced, opinion gets split in the middle. With one half seeing catastrophe ahead and the other seeing recovery, where does the market end up? The most likely answer is 'nowhere'. Performance gets lackluster and things do not look like moving. Rangebound movement is usually the result and whipsaw is frequent. But what is the prognosis?

For a trader, the best thing to do is to admit that no one knows a damn thing about the future at such a juncture. That includes the trader himself/herself. It is like driving blindfolded and is probably the most interesting (though very bank-balance destroying) trading experience.

Some things can work. Including running very tight stop losses and trading ranges. Some things cannot, as this is the worst possible time for trend followers. As the trend in the global market will take some time to emerge, there is some time for money for trend followers to show up.

The implications for Indian market are clear. Any sustained upmove in the interim period is going to be amplified by global funds as people chase higher returns. Also to be expected is a higher churn as money moves due to the shifting sectoral share in growth. While currently the Indian market is also very dull, this clarity will start dawning sooner rather than later and an amplified move can be seen emerging any time over next month or month and a half.

Good time for people who believe in accumulating stock slowly and make good money in a sustained upmove.

But keep one thing in mind; no one knows.

What not to touch in the markets?

noreply@blogger.com (Neeraj M) — Thu, 11 Mar 2010 08:46:00 +0000

INDIAN MARKETS

While the market has started moving in a direction that looks more positive, there are several danger signs that need to be watched out for. Also, many sectors in the economy are going to put in a lackluster performance and some are secular laggards over next few years. Here is the list of things that you need to avoid in the coming one year.

FMCG. All said and done, where is the growth for the sector? The only answer to that is the rural market. The food component of the business will continue to grow as the economy accelerates but the rest is not likely to grow too fast. How many soaps can you consume in a day? How much extra can you get from the same consumer for the same set of products? What do you do about the low cost competition from the unorganized sector? These are the questions that made FMCG a big underperformer in the previous bull run. Nothing has changed now to make it an outperformer.
PSUs. Other than infrastructure and perhaps banking, there isn't any sector where PSUs provide a superior growth story versus the private sector counterparts.
IT and BPO. Regardless of what people thought, reality is that a recession in the west is not a dampener for most of outsourcing related work. As firms seek to cut costs, there is countercyclical force in favor of outsourcing based businesses that dampens the effect. Now the situation has changed with anti-outsourcing sentiment as strong as ever, pressure to outsource ebbing and a currency that is strengthening; the attractiveness of the sector would be at an all time low; no matter how many "signature deals" you see. It is no longer a "growth industry". You are looking at a mature industry with moderate growth rates and valuations it deserves are more like FMCG and less like renewable energy.
Retail. The model that fueled runaway growth has failed. Period. Like the internet boom of early this decade, the industry is going to be around, just not in the same shape with the same value proposition. Rejigging the model takes time. So watch out for retail's comeback, only not in 2010.
Textiles, garments and other also rans. With the policy dice heavily loaded against this sector; little hope of a comeback. A real pity though, this is the sector with highest employment generation potential with just a little amount of training (unlike software that takes years of education). No wonder every developing country has this sector on top priority. But Indians do things just differently…

Avoiding these sectors is important for the health of the portfolio. But a winning strategy takes more than just a list of stocks to buy and to avoid. More on this later.

Time for a Secular Bull Run? Part - III

noreply@blogger.com (Neeraj M) — Mon, 08 Mar 2010 12:15:00 +0000

INDIAN MARKETS

The theme for past one year has been dominated by consumption growth (led by rural demand) and resumption of the commodity cycle. Metals were poised to gain the maximum from this theme. So were two wheelers, telecom and other consumption led sectors.

This part of growth story is not going to be as strong for next two months. The effects of bad monsoon will take some time to clear up. The disposable income delivery by the agri-sector would have happened in 4QFY10. The sector has turned out to be weak and the resulting impact on disposable income will dampen demand from this sector.

At the same time, the changing fundamentals of the economy are likely to kick-in over next 12 months. I want to caution that all the positives we have identified are slow acting and none of them is going to deliver a sharp jump up in the markets. Still, a slightly positive bias is likely to rule for next 12 months.

Which sectors are likely to lead the charge over next 12 months? There are quite a few, which provides very good diversification options to investors and traders alike (though traders will need to trade with a longer time horizon than usual to gain from this).

Banking. Favorite whipping boy of the bear runs, will likely get back in the forefront over next 12 months. Several positives, stable interest rates will not steal the wind from bond portfolio sails, rising credit offtake (particularly from housing sector), lower threat of bad loans to name the few. Some banking stocks are a "must own" in any balanced portfolio.
Real Estate. Finally out of the woods, the sector is likely to limp back to its footing over next few months. The recent withdrawal of "teaser rates" is actually a vote of confidence in the sector by the anxious bankers. They no longer feel the need to offer sops to borrowers (a "not so important/risky" set of customers) to make sure the riskier and more lucrative set (builders) stay solvent and afloat. Back to the times of rising greed and runaway prices?
Capital Goods. Must own over next 12 months. Like it or not, capacity expansion theme is here to stay. Last 18 months have seen capacity expansion disappear as "captains" of industry turned into anxiety–ridden wimps. Now that the scare is over, sooner or later, everyone is going to get the scare on the other side: "we are not poised for growth anymore".
Auto: Mildly positive. Caution needs to be exercised, with an eye on next monsoon. If it turns out to be good, two-wheelers will gain only at the fag end as rural income growth comes back.
Media: As confidence goes up, the lifeblood of the sector, AdEx, should also start rising.
Infrastructure and related (cement, etc.): Make no mistake about it, India is so starved of infrastructure today, any project is likely to make money. One of the best bets if you want safe, assured returns as a big ticket investor. The only question is, can the government get out of the way fast enough?

Along with these sectors, there are some that need to be kept at a distance. A note of caution, since they are not likely to do much over next 12 months does not mean they are easy shorts. Instead, they are more likely to be lackluster, yielding gains to neither bulls nor bears. A detailed look at some of them tomorrow.

Time for a Secular Bull Run? Part - II

noreply@blogger.com (Neeraj M) — Fri, 05 Mar 2010 11:15:00 +0000

INDIAN MARKETS

The consolidation mode markets went into over past few months has hidden a major shift in underlying fundamentals of the economy. A number of things have happened in this period.

Fiscal profligacy has come down. All said and done, the government did not fall for unlimited stimulus. I suspect a strong underlying theme would have been food inflation. Whatever the reason, a very wise decision.
Economy is recovering, though not out of the woods yet. Still, recovery sans major fiscal stimulus flowing into the economy is impressive and means that the economy can grow from here.
Liquidity. Helped in no small part by forex inflows. Government borrowing has also not gone to the level of crowding out everything else. Bond yields, as a result, have stabilized and are likely to either stay there or slowly tick down from there.

There are several negatives also, though it is better to view them as leading a 'shift' rather than pure negatives.

Failed monsoon. The impact will linger for some time. For past one year, the economy has grown on the back of a strong rural consumption story (as I continuously pointed out in my posts exactly one year ago) and negative growth in agriculture puts a spanner in that. While things should recover, rural disposable incomes will stay depressed for next six months. That shifts the focus away from consumption theme for next six months.
Low capex. A worrying trend has been the low capacity addition in the economy. It means current growth is the result of higher capacity utilization instead of capacity creation. Does not bode well for medium term growth.
High interest rates. Will take some time to come down. They are high despite good liquidity in the system and a stable sentiment. Which means any reduction in rates will be based on a slow, gradual reduction in the proportion of governments borrowings in total debt in the market.

The interesting part is that none of this makes for a drastic rise or fall in the stock markets or the fortunes of the economy. Instead, this makes for a slow and steady movement where things improve (or deteriorate) slowly.

This does not do any good to the rampant bull (or bear). At the same time, it makes for a steady secular slightly bullish market in the medium term where interest rates are either stable or slowly ticking down, economy is growing, liquidity is comfortable and consumption gradually improves as agriculture/capital goods sector gets out of the woods and capacity addition resumes.

My last year's picks, metals, auto in general and two-wheelers in particular, telecom, etc., turned out to be exactly the right picks for the market. But the changed market requires a complete reassessment of which sectors to be in. That analysis follows.