When talking about the Indian economy, are we missing the big picture ?

Posted on September 24, 2017. Filed under: Uncategorized | Tags: , , , , , , , , , , , |

So the new government got into the office on the back of a pitch that was based on a lot of hope and promises, and while I have been personally quite supportive of the need for change. I have never been in any doubt that, the changes will require time and government will have to let down people. In a country like or anywhere else for that matter, a government gets elected mostly on perception built around the hype. Average people are simply unable to breakthrough each policies and make sense of it. A country like India needs a complete overhaul of its existing economic and financial infrastructure , and that requires a lot of re-wiring and also redesigning of the entire system. Any good reforms takes time, and a prudent policy is always, to not overload the system with Big Bang reforms, one after the other, the changes have to be incremental, but constant. A system overhaul takes time, and you can’t expect the system to start firing on all cylinders right away especially when you are creating more capacity in the old system.

But economic policies alone can’t re-wire the system, it also requires better execution. And if we are talking about creating growth then, there should be a realisation that, without the ability of funding, government policies on their own aren’t the magic fix. So I don’t care what economic policies the government can come up with, driving growth in a country like India , where almost 80- 90% financing is sourced from banks simply isn’t going to work, unless and until the banks are back in shape. The fact is, the bad loans problem hasn’t been fixed, and the lenders have been too slow to offload the garbage sitting in their living room, yes there are legislative policy changes and reforms to help the banks, but banks haven’t been proactive enough. And a lot has to do with the existing training as well as mindset of the executives within the current banking system. For example, based on my own experience, I have realised that a sizeable percentage of the senior bank executives in India aren’t willing to make tough decisions, because for them, as I understood it, it’s all about a peaceful retirement and self preservation. And the investigative agencies haven’t helped decision making process either. Also some of the rule changes don’t really help the banks clean up their balance sheet. The asset reconstruction companies or ARC as they are known in India are, like a time bomb waiting to explode . On practicality basis, there is almost zero value in the ARC structure.

Without recycling the rubbish, you can’t get rid of the stinky garbage, and monetise it. Many quality ideas are simply not getting funded in India, and young entrepreneurs who could drive growth are more or less shut out from funding. And the other real issue is that, like European banks, the Indian banks are also now scared to lend. The ex RBI governor did good talking and provided public opinion on almost everything, but failed to provide real solutions, and now he is busy promoting a book.

I would prefer a wholesale reform of the financial infrastructure of the Indian economy, where capital market becomes the largest source of capital and not the banks. The regulators also need to support the government by unburdening the system from socialistic era policies. Also the government needs to do more work and talk less, there is too much distraction. A lot of announcement, but not much is getting done. Media channels have an endless lineup of experts, who probably wake up everyday, ready to provide new round of expert opinion. And the quality of journalism is rubbish, where is a decent discussion on, what reforms need to be brought in, to help the nation grow? The issue is everyone is drinking from the same source, whether you are the federal or state government, central or state government owned companies, or the private sector. And unless there is new liquidity going into the banks, it’s going to be tough to fund growth.

Various state governments across India are struggling with a very bloated fiscal situation, and they also own companies that have not made money for a long period of time, so it doesn’t make any good business sense for these states, to continue to own unprofitable companies. And in most cases, these companies are competing with other unprofitable or distressed state owned companies across India. These companies were set up in various states across the country, to provide services to the citizens, and by design they were probably never pushed to make a profit. But the time has come for states across the country to find an exit, by either privatising the companies or merging them together with similar companies in other states, and then exiting it. This will also reduce the debt burden on the states.

Also to fund growth, I will encourage the government of India to put in $ 3 billion in equity and then raise additional $ 7 billion from local banks as well as international investors/ banks, to create a growth and investment fund. This fund could also be made tax exempt from withholding taxes for foreign investors, and let this fund buy new loans from the banks, the fund could then repackage the loans in an asset backed security ( ABS) as a way to refinance itself. The fund could also provide working capital loan indirectly to the SMEs through the banks, and let the originator banks hold just 10% of the new loan on their books. RBI could also buy some of these securities from the secondary market to improve the liquidity and pricing. Also Emerging market focused fixed income investors could buy into these securities, and will be exempt from any withholding taxes. I am not a great fan of using pure debt to finance infrastructure, I would rather first raise equity to fund the infrastructure, and then give equity investors an exit by issuing the debt. If you look at it from pure risk perspective, the equity investors are in fact protected from the completion of the underlying asset, and that’s why you need a strong construction company to provide completion and construction risk coverage. So once the asset is built, equity investors will have their value protected, and the return will come from issuing the debt at a premium. There is a natural cycle, and any insurance cover to protect your investment in infrastructure asset will not work, if you simply buy a credit protection. I prefer a equity – debt- equity – exit cycle , which is based on water cycle of cloud – liquid water- ice – water – cloud. That’s the best value preservation model.

The idea that you can protect your asset for its entire life cycle carrying just debt is completely absurd, and it simply doesn’t work, any debt, if not managed well tends to have the natural tendency to end up spiralling into an unsustainable burden. And, if there was no refinancing then, most debt will not be repaid. You can repay debt from cash flow, but refinancing still remains the most frequently used tool. So we need to link the cycle especially for infrastructure assets. The issue with an infrastructure asset also is the permanent loss of value, and this is when the asset becomes redundant for a number of reasons, but if as an investor, you haven’t recovered money during the cash flow generation lifespan or lifecycle of the asset then, you are looking at a permanent loss of capital.







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Oh, Recovery, What is thy shape?

Posted on May 16, 2009. Filed under: Uncategorized | Tags: , , , , , , |

Some of my friends and colleagues are busy trying to figure out what could be the shape of the most eagerly awaited recovery. The debate is whether we are going to see a V, W, and U or prolonged I__I shaped recovery. 

 There are some who are suggesting we are probably going to see a V shaped recovery then there are those who are predicting a U or prolonged U shaped recovery and yes there others who believe we might see a W shaped recovery. Boy! Go Figure. Someone has to be right but then I wonder isn’t this all a bit premature? Aren’t we getting ahead of ourselves on making such prognoses or am I simply being Silly?

Let’s find out, shall we?

The shape of the current economy could probably give us some clues as to what the shape of the recovery might be or at the least we could rule out some.  To get a good estimate of the health of the economy let us look at some of headline news during the week ending Friday, the 15th May 09.

We will start with the numbers out from the European Union. 

According to European Union’s statistic office the GDP in the 16 member Europe region fell by over 2.5% from the fourth quarter, the steepest decline in over 12 years. This was above the market expectation of 2%. German economy shrank by over 3.8% from the fourth quarter of 08; the Italian economy by close to 2.4%; the Spanish economy contracted by around 1.8% in the first quarter of 09; the French economy by around 1.2%. Some pretty grim numbers, no doubt. The Euro zone inflation is at record low of 0.6%. Going forward the rising unemployment will dampen the consumer confidence and there is a strong possibility of inflation remaining lower the ECB’s target of 2%.

 And how are things at the corporate front? 

ING announced higher then expected net loss of Euro 793 million in the first quarter of 09. Allianz reported a fall in profit by over 98%

So how is the UK doing?

According to the Council of Mortgage Lender’s, Home repossession surged by over 51% in the first quarter of 09.  Rents for commercial properties in London fell by over 25% over a period of 12 months. The prognosis is pretty grim especially if we take into account a 56% increase in the number of companies going out of business in England and Wales in the first quarter of 09. With unemployment expected to reach 3 million by 2010 one can safely conclude that we are looking at a slow paced recovery.

Let us look at the US and others.

US retail sales dropped more then expected by 0.4% in April after a 1.3% drop in March. The new mortgage applications dropped to the lowest level since March. Consumers are mostly cash -strapped and to hope that they going to keep spending lavishly is probably a wishful thinking. On the unemployment front the news isn’t good either. The recent announcement by GM to slash its dealership network by around 1,100 and Chrysler by around 789 paints a pretty grim picture.

What about others? 

According to FSS Russia GDP shrank by almost 23% on quarter – on – quarter terms.

China seems to be doing better then the rest. The domestic investment has increased significantly but it will be unwise to assume that China be able to recover in Isolation. The exports and import number out from China are not that encouraging. With the current momentum it is safe to assume that China could grow at 7% or there about in 09 but it won’t be a position to save the world. The data out from China on the 11tth of May suggests very strongly that China has slipped into a deeper disinflation. Consumer prices fell by over 1.5 percent, factory gate prices fell by over 6.5% so it’s highly unlikely that we are going to see a significant increase in demand for raw materials from China. 

There seems to be a slow paced growth momentum building in Asia but it will be unsafe to assume that the recovery will be rapid and the growth will be on a scale seen before.

Something to think about 

When talking about any recovery I think we should keep in mind that going forward the central banks of the world and the governments will have to raise rates and taxes to fix their balance sheet and to deal with hyper inflation. And on top of that we are going to be overloaded with Heavy Regulation. That’s the aftermath. And these are not the factors that will support speedy recovery on a big scale in fact just the opposite; it will choke off the recovery. It’s pretty much like throwing a spanner into a wheel. There is so much uncertainty ahead. I think we can safely rule out a V shaped recovery. We saw most markets get back in the Red again (at least for now) the week ending Friday, the 15th May 09 on growth and earning concerns probably the markets were pricing in a pretty rapid V Shaped recovery which they now believe is extremely unlikely hence the retreat. One can’t help but wonder as to whatever happened to all the talk about the negatives being priced-in? Probably the investors are beginning to realize that the prices rose too fast without any solid fundamental support or justification for it and the massive rallies were overdone. I’m not for a moment assuming or suggesting that we are not going to see speculation driven rallies. 

Going forward 

We are not done with volatility yet. We are going to see more mixed data come out in the next quarter which will probably swing the markets both ways. The hope is that the investors will not loose foresight and look at the story behind the numbers and not get carried away by sheer sentiments like seen in the past. 

All the talk about the shape of the recovery is probably premature and a clear sign of the market getting ahead of itself. We should be able to get a good estimate of the health of the economy after the H1 numbers for 2009 are out. It should serve as a good us a pointer for 2009. It should also tell us if the worst is over or there is more to come. Looking at the first quarter numbers we could safely assume with that recovery most likely months away. 

The bottom line is what the markets need is a sustainable recovery that won’t slip out of our hands. And a slow paced recovery will probably be a blessing in disguise for the global economy. It will take time to reconstruct the financial system which we all know now was pretty flawed to begin with and  prone to boom and bust type events.

The shape is secondary honestly speaking I’ll take it in whatever shape it comes.

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