When The Acche Din Were Around The Corner…

When the acche din were just around the corner, here are two big events that have occurred in the past two weeks (Brexit and Rexit). I would like to talk about brexit in one of my other blogs, and would be focusing on Rexit ( Dr. Rajan opting out of the second term as the RBI Governor) in this one. Raghuram Rajan will step down as the 23rd governor of the Reserve Bank of India when his term expires on 4 September,2016. In this blog, I would be giving in sense of his achievements post his appointment as the RBI Guv, the likely impacts on the markets due to REXIT and the next likely predecessors for the position of the RBI Guv. I will also share statistics in terms of the key indicators before and after Dr. Rajan took over on the Sept 4, 2013.

From converting the Reserve Bank of India into an inflation targeting central bank to forcing a long overdue clean up of the banking sector, Rajan’s three year term has created significant progress. Dr. Rajan, has always been a inflation targeting Guv since the belief was strong that neither higher inflation nor lower interest rates are going to boost growth solely, the growth is always a mix and balance of the two parameters. With his highly focused regime of concentrating on the monetary aspects of the economy by considering various external and internal events has been effective in all the possible ways.

Here’s a list of the key improvements/actions/achievement by the veteran:

  1. MPC (Monetary Policy Committee) – Dr. Rajan announced a committee to review the monetary policy. Although, the attempt was then tweaked by the Govt in such a way that currently there is a hint of RBI Guv losing his rights to take the final decision on the policy actions.
  2. Inflation Targeting – Right after taking over as the governor, Raghuram Rajan appointed a committee to review the monetary policy framework. The committee recommended that the RBI formally shifts its focus on to the consumer price inflation index as the nominal anchor for monetary policy in the country rather than WPI. As part of this framework, the RBI was to bring down inflation to 6% by March 2016 and 5% by March 2015. Over the medium term, the RBI now has a target of bringing inflation down to 4% (+/- 2%). Looking at the current situations, the RBI has fairly achieved its targets.
  3. Revitalization Stress Assets – RBI took various measures against the stressed assets of the banking sector especially in terms of the corporate and strategic debt restructuring norms.
  4. Bank Licensing – While the process of licensing another round of universal banks was kicked off during D. Subbarao’s tenure, Rajan’s tenure saw two new banks (IDFC Bank and Bandhan Bank) being licensed. The more significant step in this context, however, was the licensing of differentiated banking licenses.  11 payment banks were given an in-principle approval and at least eight of them will launch operations by early next year to increase penetration in the rural economy. In addition, ten small finance banks were also given in-principle licences to serve small borrowers and businesses. Rajan also floated the idea of wholesale banks and custodian banks, although, with no guidelines as of now. The RBI put out a draft framework for on-tap universal bank licensing as well.
  5. 5/25 Scheme – RBI allowed corporate to extend tenors of credit in case of infrastructure projects thus providing them with a higher gestation period.
  6. Market Development – Market development has been top of the agenda for Rajan as well. The RBI, under Rajan, has also for the first time put in place a framework for foreign investor participation in the bond markets. The RBI may start accepting corporate bonds as collateral for its liquidity operations.
  7. Repo Rates Decline – Repo rates were brought down to 6.5% ( Lowest in the past 6 years) with inflation targeting as the key focus.

Apart from the above mentioned monetary measures taken, Dr. Rajan’s timely actions on the monetary policy decision has enabled a huge change in the key macro economic indicators of India before and after Dr. Rajan taking over. There has been a huge difference in the numbers including the credibility in the world economy and the reduction in the instability of the economy. Here’s a quick stat on that:

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Although, it was an extremely surprising decision by Dr. Rajan, it was very well anticipated looking at the tension between the RBI and the Govt in the recent past. The markets have reacted negatively because of the sudden decision to not continue. The short-term blip will continue for the next 3 months and might settle down once the monetary front is stabilized post appointment of a new RBI governor. However, markets will keep dipping in the short term amidst the uncertainty on the global front, whereas the medium and long-term trend look significantly bullish.

Who Will Fill Rajan’s Shoes:

Lets look at behind-the-scenes scenario of how the RBI Governors have been appointed till date. Even though the Appointments Committee is the official vehicle to do the job, typically, the Prime Minister’s Office chooses the governor with inputs from the finance ministry and the outgoing governor and, on most occasions, there is no written recommendation. The politicians of the ruling party play an important role in the selection but the corporate houses that normally try to influence the appointment of CEOs of commercial banks do not have a voice here, although they have their own preferences.

Here are some of the options that the government may consider as it searches for the 24th governor of the RBI. The four likely candidates are: the current RBI Deputy Governor Urjit Patel, former deputy governors Rakesh Mohan and Subir Gokarn, and State Bank of India Chair, Arundhati Bhattacharya.

Here’s our quick analysis on who would be the probably choice of the Govt:

  1. Rakesh Mohan – A former Dy Guv and a veteran economist. Logically, he will be apt for a fiscal role rather than a monetary chair role due to experience in the former. However, politically he might stand a chance in case the Govt is looking for an economics reforms expert to head the RBI.
  2. Subir Gokarn – A former Dy Guv and a veteran economist especially in the areas of food inflation and inflation related research. However, he might not be the right candidate to head the RBI since that would require the expertise and experience on handling the monetary front of an economy.
  3. Arundhati Bhattacharya –  A career banker, Bhattacharya may make a good candidate against the bad loan crisis in the banking sector. The trouble with appointing Bhattacharya as the head of the central bank is that there is no precedent in recent times of a banker being appointed as the RBI governor. While one of the four RBI deputy governor’s is always a senior banker, the central bank chief has typically been someone who has had an understanding of the wider economy.
  4. Urjit Patel – Current Dy Guv of the RBI. Urjit Patel, who chaired the committee on a new monetary policy framework, has overseen the RBI’s transition to an inflation targeting central bank. Patel has also been driving the central bank’s liquidity policy as well. According to me, Urjit Patel has the highest probability to be appointed as the next Guv of the RBI. However, the political front of the appointment may be different from the predictions that are logically sound.

To sum up, India was in deep trouble in terms of macro economic indicators and the stability of the economy. Dr. Raghuram Rajan, took over on 4th Sept, 2013 and changed the overall image and credibility of the economy. However, it is a sad event that he choose to return back to academia from being the dashing RBI Guv. Although, he has made his choice to join academia, he will always be remembered as the youngest and the most respected Guv of RBI in the coming years. It will be difficult for any other veteran to fill in his shoes, but however, Urjit Patel and Arundhati Bhattacharya look to be the probable candidates to head the RBI so far. When the acche din were around the corner, its hard to believe that Dr. Rajan has quit. 

Thank you. 🙂

 

 

 

 

 

 

Wrong Move?

The US Fed, in its last policy meet for the year, held on 15th and 16th of Dec, decided to break it’s near zero interest rate trends. The US Federal Reserve on 16th Dec, 2015 decided to raise its interest rates for the first time after the sub-prime crisis era. Although, the hike was anticipated much earlier in the year, lack of strong data in terms of unemployment rates and inflation was a hindrance. Ultimately, on the basis of fairly strong data, the Fed has decided to step on the gas. The question is” was this a wrong move”? In this blog, I will focus on the data considered by thr Feds for a policy action, inflation targeting, rationale behind the rate hike decision, why is the hike unconventional and the history of the impact of such unconventional measures. To conclude, I would provide an insight on the policy modes of the major economies, the likely impacts on the US economy, global growth and the financial markets worldwide.

The Federal Reserve, in its final policy for the year, increased the interest rates by 25 bps from 0%-0.25% to 0.25%-0.50%. Fed was focusing on the data from the past 5 years to understand the feasibility of a rate hike. For the readers, it is important to know that a rate hike will start taming inflation and choke the growth in the medium term. Feds have been closely tracking two critical indicators namely, unemployment rate and the retail inflation numbers. Feds had their targets for unemployment rate to drop below the 5% levels while inflation rates to touch 2% trending northwards. The growth rate so far has been on the lower side, but as every other developing and developed economy, the US is has a focused inflation targeting.

Here’s a graph to explain the readers briefly the interest rates and inflation trend:

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Interest Rate Trend 2005-2015
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Inflation Trend 2005-2015
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Feds Target Line Not Crossed

The rationale of the US Fed behind the rate hike was a fairly upward trending inflation and lower unemployment rates. The above images show that, despite not achieving the inflation target and the unemployment rate benchmarks, the Fed increased its interest rates in a non conventional manner. The tone of the policy statement indicated that they are expecting the inflation figures to rise further and the unemployment rate to continue its downward trend as shown in the graph. Inflation is rising but the average figures for the year 2015 is 0.5%. It is unlikely that the figures will rise up to the 2% levels  in the near future due to lack of domestic demand in the US.  On the other hand, a rate hike will choke the growth as well as tame inflation, which will beat the purpose of the rate hike  in the first place. Secondly, the Fed said they expect the unemployment rate to inch downwards from here on. But here’s what has happened from 1971 till date to the unemployment rates whenever the interest rates have been change. Unemployment is directly related to the movement of the interest rates. The below graph and the movements suggest that even the intent of bringing the unemployment rate down is not achieved with a rate hike. Its a challenge from here on how the Feds are going to contain the effects or if I may say the ill-effects of the decision.

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Whenever interest rate has increased, the Un-employment rate has increased as well and vice versa

Lets take a look at the history of the effects of unconventional policy actions. European central bank raised the rates twice in 2011, killing a nascent recovery and plunging the euro zone into a double-dip recession that it is still struggling to overcome. In between the years 2004-06, Feds steady quarter point increase in the rates (which was an attempt to avoid the bubble creation), was not enough to stop the implosion of the housing bubble in 2008. In the above mentioned scenarios, the problem was either the central banks acted too slow or too fast, whereas it would have been prudent to take appropriate actions. 

With growth still sputtering in Europe, the ECB has been embracing the tools used by the Feds years ago to revive the economy i.e Quantitative Easing. ECB has kept its rates to near zero levels to try and revive the economic conditions with QE, although the revival might take a little more time than expected. Whereas in Asia, PBOC (People’s Bank of China) is also on a easing mode. Similarly Japan is keeping its interest rates at rock bottom levels to encourage growth. India as well has joined them by reducing its interest rates by almost 125 bps from Jan 2015. With the globe on easing mode, it is going to difficult for the US to justify its tightening with the global growth being already quiet subdued. The growth rates for the US in the first half of 2017 are expected to be on the lower side because of the tightening. US also has been a reasonable contributor to the global growth, and with this tightening we can expect a much lower share from the US and consequently lower global growth. The USD as well is expected to harden against the rest of the currencies hurting the exports and thus undermining the trade balance. Markets all over the globe are expected to reap fairly low returns as compared to last year in the medium term. To sum up, with its unconventional policy actions of a hike when the rest of the economies easing to spur growth, the Fed has increased the probability of a further slowdown in the US. If there is no inflation, the growth cannot happen or if I may say if there is no growth, there might not be any rise in the inflation. Currently, US does not have either in place (Insufficient growth to drive inflation and insufficient inflation to drive growth). But, on the brighter side, with US, China, Europe and Japan on a slow lane, India might be the star performer in the coming year with highest growth rate in the emerging economies as well as the world. But, with winter session wiping out without the GST passage, the path on the fast lane does not seem to be easy. However, the prospects for India are significantly good from here on with an expectation of the reforms rolling out in the budget session.

Thank you.

🙂

 

The Decisive Session

The parliament winter session (the decisive one) commenced on the 26th Nov, 2015. Parliament will hold the meet till December 23rd, 2015.  The session agenda includes 19 Bills currently pending in Parliament for consideration and passage (including the GST Bill).  14 new Bills are proposed to be introduced. Out of these one will also be taken up for consideration and passing.  Two Bills will be withdrawn. With a fairly stable signals so far, the winter session productivity does seem to be significant with close to 73% productivity. In this blog, we will focus on the productivity of upper house and the lower house in terms of results as well as the time spent. We will also focus on GST and the progress so far including the Arvind Subramanian committee recommendations. Finally, I will also conclude with the likely outcomes of the session, its effects on the GDP growth and the direction of the markets in the medium term.

For the readers, here’s what I discussed about GST in detail in one of my previous blogs:

ALL YOU NEED TO KNOW ABOUT GST

Lets first understand the major bills that will be due for discussion in the session. Here’s is a brief note on the same.

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The productivity of the sessions has been a significant driver of the reforms and development in India. However, history suggests that no session of the rajya sabha apart from the budget session has been productive. In the NDA Govt tenor as well the history has repeated itself with low productivity in the monsoon session. GST has been facing strong opposition for the structure of the bill. To get a sense of the productivity and performance against the plan, here are a few images that might help to give a clearer picture. 

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Total Productivity of Rajya Sabha in the Budget Session
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Total Productivity of Rajya Sabha in the Monsoon Session
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Productivity of the winter session as on 30th November, 2015

 

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Budget Session – Plan Vs Performance
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Monsoon Session – Plan Vs Performance

While productivity has been one of the issues, the strong opposition to the GST passage is still a concern for the NDA Govt. GST has been facing an opposition in terms of the structure, exclusions and inter-state tax. With 3 committees already publishing their recommendations, opposition was persistent with their demands. NDA Govt thence decided to form a committee headed by the Arvind Subramanian(Chief Economic Advisor to the PM). The key recommendations of the CEA led committee were:

a) Recommends eliminating all taxes on inter-state trade.

b) GST panel has suggested standard rate of 17-18%

c) Panel not for specifying GST rate in Constitutional Amendment Bill

d) Panel recommends bringing alcohol, petroleum within GST

e) Committee suggests revenue neutral rate of 15-15.5% for GST

f) Allocation to states will depend on revenues raised by Centre and states

g) Two options for the states: Single rate of 15% or a range of 17-18%

h) GST rate on precious metals to be in the range of 2-6%

i) Panel recommended removal of 1% additional levy

j) Higher GST rates on tobacco, luxury cars, pan masala and aerated drinks

k) The panel kept alcohol, real estate out of GST to achieve 15% rate

The NDA Govt will now be again presenting the GST bill with the required changes if they accept the CEA recommendations. If the NDA Govt succeeds in putting up a viable solution for the oppositions demands, it would truly make GST, one of the biggest reforms since independence in India. Although, the hopes are slightly on the lower side, things might change from here on if a mutual motive is maintained. The silver lining of the winter session was the passage of the Real Estate Regulatory Bill (2015) today, which is intended towards consumer protection and might be a way to maintain the market dynamics in this era of sky high real estate prices. One of my blogs might give readers a fair idea about the Real Estate Regulatory Bill.

Real Estate Regulatory Bill

To conclude, the path towards the GST passage looks rough for the NDA Govt so far. It might be right to say that the winter session might not give be able to deliver the said reforms. The non passage of GST will definitely be a huge setback for the Govt and might affect the GDP in the coming future due to the leading weak investment sentiments. On the other hand, markets with significantly low hopes about the GST passage, might head south in the medium term (Uptil the first quarter of FY 2016. Markets look volatile in the short term and might continue to be the same at least, till the US Fed meet due on the 15th of this month. Markets will be looking forward to the Budget session for a push in the reforms from here on, if at all the winter session turns out to be an unproductive one. It would be the appropriate time to move things forward in terms of reforms and use the current conditions of low commodity prices to our benefit.I hope, the Center and the opposition will start putting up a few actionable steps in place for the betterment of the economy on a macro level, rather than hinting a political vendetta. 

Thank you. 🙂

 

 

The Glencore Glitch

World economy has been facing a global slowdown since the start of 2014. Majority of the economies, leaving out a few emerging economies, have so far bottomed out in terms of their GDP growth numbers in the recent quarters. The most significant signs of the global meltdown are the recent fall in global commodity prices amidst subdued global demand and peak volatility in energy prices. The fall in the commodity prices has been beneficial for countries who are net importers of these commodities but have severely dented a few Oil producing nations and oil marketing companies. We witnessed, Saudi, Yemen, Russia, and other OPEC nations selling off oil at prices as low as $44/barrel leading to tensed economic conditions. But there were few companies and countries which were probably ignored because of their strong reputation. One of them is Glencore Plc. In this blog, we will talk about Glencore, its business dynamics and the glitch that might cause a serious threat to the global economy.

Before we proceed, let me brief the readers about the background of the company. Glencore Plc (Glencore), the Global Energy Commodity Resource, a multinational giant in commodity trading and mining. It is probably the largest company in Switzerland and the world’s largest commodity trading company. It facilitates trades of various commodities such as zinc, copper, grains, oil etc.

Picture1

Going back to 2013, we witnessed the global oil prices started tumbling from $110 / barrel to an average price of $50 / barrel. Similarly, the copper prices also started tumbling in the recent year with the fear of weak demand and oversupply amidst Chinese slowdown. The above image show the trading share of Glencore. The image given below give a brief idea on how the revenues share is dependent on these tumbling commodities.

gglencore sector division

Is anything fundamentally wrong with Glencore? Was it considered a debt burdened company before although having the same levels of debt?  The answer is no. It is a levered bet on not only china but on the fate of copper and oil prices in the near future. Lets focus on what has happened in the recent past. With the falling commodity prices since the last 18 months, amidst China slowdown, Glencore has been a counter-party with China in Chinese Copper Financing Deals. The Chinese traders have been using copper as a tool for carry trade by creating artificial demand. The following image will give a brief idea of carry trade on copper.

carry

Precisely, China is creating 70% of the demand artificially by selling off copper and taking positions in futures market to buy it back after 13 months. On paper the demand is definitely existing but it might happen that the same contracts are rolled over. This might make Glencore’s position weak since the contracts are existent but the actual cash flows might be deferred for a longer period. With this fear, two rating agencies namely Moody’s and S&P downgraded Glencore’s rating to BBB with a negative outlook. The BBB rating with a negative outlook is just a notch above the non investment grade rating. The results have dented its share prices in the past few months. As a corrective action on the entire situation, it announced a dramatic recapitalization plan, one which would see it not only scramble to raise $10 billion in capital through an equity offering, asset sale and capex cut, but become the first major copper supplier of scale to cut production and indirectly benefiting its biggest competitors. Apart from the copper, various other commodities and major currencies have witnessed turmoil and it is unlikely that Glencore will be decoupled from the effects of the same.  Here’s a snapshot of Effect on EBIT vs Sensitivity of Various parameters.

Glencore EBIT Sensitivity

To sum up, with the commodity prices heading southwards it seems difficult for Glencore to recover. Although, they are trying to raise fresh capital and reduce their debt with the same, it is unlikely that they can control the external events predominantly related to the Chinese economy. In the midst of the events stated above, questions are being raised about the solvency of Glencore. What if Glencore fails to sustain the further fall in commodity prices? Well, since Glencore is not just a miner but probably the world’s largest commodity trading desk, and a key commodity counter-party, especially in Chinese carry trade deals, the answer is probably simple – Glencore might turn out to be a Lehman Brothers, only this time in the commodity space. 

Thank you. 🙂

“Bears” in action..”Bulls” seem far-fetched..

bullbear

Bulls and bears are the trends when we speak about the stock markets. Indian stocks markets these days are witnessing a bearish (downward) trend amid various issues. Stock markets have tumbled in the past two weeks because of the weak sentiments and rather weak implementation of reforms. Modi Govt has so far failed to maintain the sentiments of the bulls. Experts and investors are of the view that the Modi Govt has just been words till date. So why are we witnessing this bearish trends?

Indian markets are fairly dependent upon investments by FIIs( Foreign Institutional Investors) and FPIs( Foreign Portfolio Investors), also termed as “Hot Money”, which makes the Indian markets vulnerable to any uncertainties.

Presently, the MAT (Minimum Alternative Tax) issue seems to have reversed the bull run. (Here is a brief idea of what MAT is: It is a minimum tax to be paid by companies making substantial profits but which seem to have no significant income on paper due to deductions and exemptions)

” The hardest thing for a human being to understand is tax laws” – Albert Einstein

MAT as such is only applicable to the companies where the income tax calculated under the IT Act is less than 18.5% of the book profit. Companies coming under the exemption of DTAA(Double taxation Avoidance Agreement), 89 countries out of which 87 treaties are active, continue to enjoy the tax-free income from the capital gains. Roughly, a week ago, the IT Dept sent out notices to around 68 FII and FPIs demanding a tax liability of Rs. 602 Cr. This step created a havoc in the markets regarding the tax reforms in India. Post this, FPIs started pulling out money from Indian markets and thus putting downward pressure on the index. Although the MAT issue has now been resolved for the future years, MAT is still going to be applicable to FY 2014-15 capital gains and we might see a further bearish trend in the coming weeks.

On the domestic side of the economy, Indian steel and tyre industries are in a highly distressed condition. China and Japan who are currently sitting on a huge inventory of steel and tyre produce, are dumping the entire stock in the Indian markets at a price cheaper than persisting indian costs. Frankly, we cannot stop the supply from Japan because of the free trade agreement. China on the other hand can only be restricted by certain import duty changes. MoF needs to take some serious steps in regards to increase import duty on steel. Collectively, it has lead to weak corporate earnings and finally added to the ongoing bearish trend.

On the other side of the globe, Euro Zone has replaced US in investment grades. ECB’s QE(quantitative Easing) seems to have worked in reviving the economy and ending the deflation phase. Although, “Grexit” still remains a key concern in determining the direction of the Euro Zone. US has registered a GDP growth of merely 0.2% in the first quarter thus suggesting a slow progress. Reasons being the abnormally cold weather, cautious consumption and strengthening of the dollar. Fed interest rates hike is thus unlikely till about Sept this year.

In technical analysis jargon,  the index has breached the vital 200 DMA (Day Moving Avg), which indicates further fall from the current levels. The trend can be expected to continue in the same direction if the scenario remains unchanged. In fact, this can be an appropriate opportunity for the aggressive traders to grab the value stocks and gain appreciation of the value in the long run.

Thank you 🙂