A crisis of confidence
Two decades back, a balance of payments crisis forced India to adopt an IMF program that led to the announcement of a reforms package. Dr. Manmohan Singh, India’s Prime Minister for the past seven years, was then the Finance Minister. As such, expectations of corporate India and international investors have remained high. In his first innings as the Prime Minister, Dr Singh and the Congress Party shifted the responsibility of slow pace or lack of reforms to coalition politics, of which the Communist Party was a key partner. In 2009 the Congress Party was reelected and, this time without having to rely on support from the Communists, the expectations soared. Unfortunately over the last two and half years, the government has not made much progress in pushing through key reforms.
The accomplishments of Dr. Singh as the Finance Minister in the 1990s are now dwarfed by what remains to be done. There is an increasing feeling amongst the masses that our political leaders have failed us miserably. And this has happened at a time when the developed world with zero interest rates and virtually stagnant economies is seeking growth opportunities. Instead of coming together and agreeing on economic policies that could propel India as an economic power, our leaders are busy scoring political points. To quote Sunil Mittal: “India is not at war from outside, but there is a sense that it is at war from within.”It is bigger than the global crisis of 2008; it is a crisis of ‘confidence’ or ‘governance’, which has dried up because of a Government that no longer has the stomach for taking major policy decisions.
Dr. Shankar Acharya in a recent article titled “The darkest cloud is the government’s failure to acknowledge India’s worsening economic situation”summarises the present situation in India: “As autumn shades into winter, the clouds over India’s economic performance and prospects are getting bigger and darker. First, the international economic climate is getting gloomier by the week, with a rising threat of a major ‘event shock’ from Europe. Second, India’s economic growth has slowed and there is growing evidence that the deceleration will continue. Third, aggregate investment has slackened and it could get worse. Fourth, inflation continues to be stubbornly high, fuelled in part by a worsening fiscal deficit. Fifth, the country’s external imbalances are growing at a time when capital flows are becoming more volatile. Sixth, and perhaps most worrying, there is little evidence that the government appreciates the gravity of the problems and even less that it has capacity and the will to coordinate and implement an effective programme to mitigate the rising threats to economic performance”.
The situation is bad, very bad but it is not irreversible. A number of industry leaders and other eminent persons have written to the government urging it to get on with governing the country and ignore political implications. There is a serious negative perception that is now being created about India at the global stage. This is hurting India, not because the Indian story is over; far from it.
Two contrasting markets
Investors are always eager to grasp at straws of hope. When a package was announced to bail out Greece in end October 2011, markets heaved a sigh of relief and, rallied. But that lasted for a couple of days. Then came news about problems in Italy and increase in bond yields in France and finally, failure of talks to reduce debt levels in the US. There is now a sense of uncertainty prevailing in the West. The US is facing an uphill task of injecting growth in its economy. In Eurozone, concerns about sovereign defaults continue to mount and, the crisis has already forced out two governments. This uncertainty extends beyond countries and regions.
Markets across the globe are in the red – there is a blood on the street, on every street – right from US, Europe, Japan and Asia including India. However, we in India are seeing blood when we should have been the darling of global investors – both for FDI and portfolio investment – and, as I have mentioned earlier, it is of our own making. All this has happened simultaneously.
Under the circumstances, the role of leadership or the lack of it has a serious impact on business and investor confidence. This calls for a change in mindset amongst the leaders who are used to addressing issues using traditional methods, processes and opaque governance systems. By next year, India is likely to be a two trillion dollar economy. Despite a drop in expected growth rate, it will continue to be one of the largest and fastest growing economies in the world. What is needed urgently is to move forward with the unfinished reforms agenda which, unfortunately, cannot move without our politicians and leaders moving responsibly.
Government seeks an image makeover
Although the latest figures suggest that food inflation is now in single digits, RBI has remained unsuccessful in containing inflation despite raising interest rates over last one year. According to the RBI Governor, a significant increase in rural wages triggered by the Rural Employment Guarantee Scheme, aimed at inclusive growth, increased demand for food products leading to a stubbornly high inflation. The high food inflation was intriguing, especially if one looks at a record food grain production, robust buffer stocks and accusations of excess stocks rotting in the fields. It was clear that the dynamics had changed significantly over the last few years.
The Government that was dithering on allowing FDI in retail has finally acted and, increased FDI limit in multi brand as well as single brand retail even though this has invited objections from various political parties, including some of its allies. We sincerely hope that this decision is the beginning of more economically sound policy announcements from all the political leaders. While these measures are unlikely to have an immediate impact on inflation control through supply side management, these could open doors for inflow of foreign investments that has reduced to a trickle in the last few months. In the longer term an improved supply chain should help inflation management by controlling a spiral in prices of agri-commodities, something that the common man has been exposed to in the last couple of years.
Corporate Results disappoint
Corporate performance for the quarter ended September 2011 has been disappointing with most companies reporting a fall in net profits as compared to corresponding period of the previous year. Profit erosion this time has been worse than in post-Lehman period. Indian companies seem to be having a tougher time this time around.
The reasons are not difficult to find. Interest costs have shot up and commodity prices which had collapsed in 2008 are higher. Many companies also had to provide mark-to-market foreign exchange losses. Perhaps and most importantly, the government, that could stimulate the economy and offset any fall in demand from the private sector, is battling a fiscal crisis. It is likely that the bottom of the investment cycle has not yet been made, which means that profit growth could continue to be lower in the next one or two quarters.
There may be some solace: over the next few months, a decline in commodity prices is likely due to a reported contraction in Chinese manufacturing. In a recent report, The World Bank has forecast a decline in China’s GDP growth from 10.4 per cent in 2010 to 9.1 per cent, and further to 8.4 per cent in 2012.
Rupee Depreciation made matters worse for India
The Indian Rupee is Asia’s worst performing major currency this year, having tumbled around 17 per cent. The fall is due to a combination of a lower risk appetite among global investors, spooked by the euro debt crisis, and pessimism about the Indian economy. A volatile currency and dimming outlook for overseas flows have also hurt the government bond yields that have surged. Apart from hurting corporate profitability, rupee depreciation is also translating into higher inflationary pressures.
V.Balakrishnan, CFO of Infosys rightly says: “Rupee’s volatility is insane and it needs to be put under control. We need a stable currency otherwise it harms the entire economy and hurts both importers and exporters, because in the same quarter we went from around Rs.45 to Rs.52.5 against the dollar.”
Foreign Investors are the worst sufferers of sharp rupee depreciation as all their assets are in India are rupee denominated and a 17 per cent decline in the rupee in a market which is not performing well is a double whammy for them.
We are committed to investing in growth stocks at value prices
The mayhem in the stock markets has impacted the performance of equities across the globe. In this scenario a fall in prices of mid cap companies (that form the investment universe of QuestPMS) is disproportionate to the trading volume or a change in fundamentals of the company.
During the month, we created some liquidity in QuestPMS. The idle cash has been invested in liquid mutual funds. These can be liquidated within a day to capitalise on any investment opportunity.
We may be disappointed with the short term performance of QuestPMS but certainly not disillusioned about our investment philosophy. We remain confident about our approach and believe that it should deliver absolute returns as opposed to relative performance to our investors.
Turbulent times offer opportunity to long term investors
Despite all the negatives, foreign large institutional investors are not selling India aggressively. There are clear reasons for that: Unlike developed countries, India will continue to grow at least six per cent in terms of GDP and 12 to 15 per cent in terms of earnings (on a normalized basis). Second, markets are normally sensitive to monetary policy announcements, and there is a belief that in India the interest rate cycle has peaked and can potentially reverse in the next few months. And third, if the government succeeds in introducing some reforms, India Inc’s confidence should improve reversing the slowdown in investment. This can quickly and decisively move the market upwards. As clarity emerges, domestic investors, mutual funds, insurance companies and FIIs that are sitting on high level of liquidity could emerge strong buyers.
While the current turmoil may continue for next few weeks or months, it cannot continue forever. Markets could even fall further from hereon, but the bounce whenever it comes will be equally strong. One can’t obviously time the market to the perfection. Instead what is required is conviction backed by holding capacity so as to ride the crisis period. Baron Rothschild, an 18th century British nobleman and member of the Rothschild banking family, is credited with saying “The time to buy is when there’s blood on the streets.” Mark Mobius in his book Passport to Profits has said that there is a second part to Rothschild’s quote: Buy when there’s blood on the streets, “even if the blood is your own.”
To conclude, it is certainly not all doom and gloom. We do not have the skills to forecast macro variables, but if we have to hazard a guess it would be that by March 2012, inflation should fall prompting RBI to reverse its hawkish stance. That may be favourable not just for the Indian equity market but, we suspect, also for the rupee. There is a pent up demand amongst foreign institutional investors to participate in India’s growth but there is clearly a case for improving their confidence that the India Story is still on track.
November 30, 2011
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DISCLAIMER: This communication does not constitute or form part of any offer or recommendation or solicitation to subscribe or to deal with QuestPMS. The views expressed by Ajay Sheth, Portfolio Manager QuestPMS are his personal views as on the date mentioned. These should not be construed as investment advice to anyone. This communication may include statements that may constitute forward looking statements. The statements included herein may include statements of future expectations and are based on the author’s views, observations and assumptions and involve known and unknown risks and uncertainties that could cause the actual results, performance or events to differ substantially or materially from those expressed or implied in such statements. The author does not undertake to revise the forward looking statements from time to time. No representation, warranty, guarantee or undertaking, express or implied is or will be made. No reliance should be placed on the accuracy, completeness or fairness of the information, estimates, opinions contained in this communication. Before acting on any information contained herein, the readers should make their own assessment of the relevance, accuracy and adequacy of the information and seek appropriate professional advice and, shall be fully responsible for the decisions taken by them.