Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Over the last month or so, we have been reminded several times as to how cheap Indian
assets (equities, bonds or the currency) have become relative to historical levels. While we
are not opposed to tactically long, it is important to note that rising structural stresses are
calling for a reset of valuations. These structural stresses have risen primarily from the
populist policy framework. In the pre-Lehman period, they were either less pervasive or were
overshadowed by the strong growth momentum.
Degeneration of fiscal policy has been the most apparent manifestation of the current
administration’s populist policies. Reining in the fiscal deficit in the post-Lehman crisis has
proven to be difficult. In the three years preceding the Lehman crisis, the deficit had averaged
3.5% of GDP and was on a declining trend in accordance with the requirement of the Fiscal
Responsibility and Budget Management (FRBM) bill. Post-Lehman, the deficit has averaged
6.1% of GDP, if one-off windfall gains such as receipts from sale of 3G spectrum license fees
are stripped out.
While the higher deficits in FY09 and FY10 (fiscal years ending March 2009 and 2010) could be
attributed to the need for a economic stimulus, it is difficult to extend this sympathy in the
subsequent years. The FY12 budget is a case in point. The target for the year is 4.6% of GDP.
After one quarter in the fiscal year, there is little doubt that the deficit target will be breached and
by a wide margin primarily because of mounting fuel prices. According to the RBI, the slippage
on account of fuel subsidies and the revamp of fuel related customs and excise duties alone will
be close to 1% of GDP. Add to it that the YTD revenues from disinvestment have been only
INR11.5bn compared with a full year budgeted level of INR400, the overshoot in the deficit could
be significant. We expect the deficit to be 5.5% to 6% of GDP
What are the implications of worsening public finances? This fiscal stance has created tensions
for monetary management in several ways, but most notably via inflation. The RBI has been of
the view that the high level of deficit has kept aggregate demand and consumption in particular at
artificially high levels and has added to the inflationary pressures. It has also negated the effects
of rate hikes. In fact, in the latest monetary policy, This policy mix of expansionary fiscal/tight
monetary was last evident in the mid-1990s.
This is at an aggregate macro level –micro repercussions also deserve a mention. One of the key
policy agendas of the current administration has been generating rural employment via the
NREGA (National Rural Employment Guarantee Act). The act provides 100 days of employment
to one member of every rural family each year. Initially, wages for this scheme were set at prespecified
levels but more recently have been linked to inflation. The immediate impact of the
NREGA was positive to the extent that it helped in raising rural incomes and lowered rural –urban
disparities.
The programme has however, not resulted in any meaningful improvement in agriculture
productivity. The objective of the NREGA was to create rural assets/improve productivity
alongside higher rural incomes. As this is not happening at least, at a reasonable pace, the
demand-supply situation has become imbalanced. Higher rural incomes have lifted the demand
but not the supply of food
More importantly, labour shortages have surfaced in some parts of the country. Pre-specified
wages (which were above minimum wages to start with in several stages) and their more recent
benchmarking with inflation has reduced the supply of unskilled labour not just in the agriculture
sector but also in industries like construction. Consequently, wages are reportedly rising faster
than productivity and in fact, raising the risk of a wage-price spiral.
A second area of concern has been the slowdown in the investment cycle. As discussed in
previous reports, the combination of lacklustre reforms, rising cost of capital and a lacklustre
recovery in information technology related exports has dented investment activity. Our estimate of
the cost of capital based on a equally weighted average of 5 yr AAA corporate bond yields and
the earnings yield shows a remarkable rise over the last few months
The reforms process meanwhile remains weak. Even though it is likely that some measures such
as foreign participation in multi-brand retail may finally go through, the overall process clearly
lacks direction. As an example, investment in the infrastructure sector continues to be plagued by
issues like environmental clearances, unclear and impeding norms on land acquisition and
absence of coal linkages for power sector projects. Likewise, poor governance vis-à-vis effecting
user charges in the power sector have resulted in high transmission and distribution losses of
around 28%. These losses have undermined the confidence of private players in the sector.
These headwinds indicate a continuation of weak investment activity. The dismal growth of 0.4%
yoy in the January-March 2011 quarter may or may not be repeated – the point however, is that it
is likely to languish at weak levels.
What about the bright spots in the economy. Optimists have pointed to us the amazing vigour of
exports. India’s exports have outperformed those from the rest of the region by a sizeable margin.
We are however, more sceptical about the true level of export growth. There appears to be
growing disconnect between growth in exports and port traffic (Figure 5). Considering that
engineering goods and petrochemical products, the two main drivers of India’s exports in recent
months, are generally transported by sea, the anomaly is interesting. It is possible that much of
the impetus to Indian exports has come from higher prices. Even so, there appears to be an
element of overstatement. By considering purchases by Asian economies from India, we find that
India’s report exports were roughly 21% higher than those reported from India.
To summarise, the overall backdrop is one opposing fiscal – monetary policies, risk of a wage
price spiral, sluggish reforms and faltering growth impact asset prices. Solutions are of course,
available but implementing them would require political resolve. The existing track record does
not give us much reason to expect any speedy implementation.
This backdrop contrasts significantly with that in the pre-Lehman period. Apart from the early part
of 2008, inflation was reasonably contained, the fiscal deficit was correcting and there were many
more catalysts to growth. These included the advent of consumer financing, rapid growth in the
on-shore business processing and telecommunications industries. The fillip to growth from these
new activities was significant.
This deterioration is showing in a reset of asset prices. The price earnings multiple has now been
treading water almost since the beginning of 2010 and Indian bond yields have diverged from US
yields. To some extent, this divergence in bond yields can be attributed to an even poorer state of
the US economy and diverging monetary policies. Nonetheless, it would also be fair to say that
from a regional context the divergence of Indian bond yields has been relatively unique.
The same has also been manifested via a smaller surplus on the capital account. As Figure 6
shows, the surplus on the capital account has recovered in the post-Lehman period but has
settled at much lower levels. This contrasts with developments in the ASEAN region, where
capital flows have strengthened. We believe this is a reflection of the state of the economy.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Over the last month or so, we have been reminded several times as to how cheap Indian
assets (equities, bonds or the currency) have become relative to historical levels. While we
are not opposed to tactically long, it is important to note that rising structural stresses are
calling for a reset of valuations. These structural stresses have risen primarily from the
populist policy framework. In the pre-Lehman period, they were either less pervasive or were
overshadowed by the strong growth momentum.
Degeneration of fiscal policy has been the most apparent manifestation of the current
administration’s populist policies. Reining in the fiscal deficit in the post-Lehman crisis has
proven to be difficult. In the three years preceding the Lehman crisis, the deficit had averaged
3.5% of GDP and was on a declining trend in accordance with the requirement of the Fiscal
Responsibility and Budget Management (FRBM) bill. Post-Lehman, the deficit has averaged
6.1% of GDP, if one-off windfall gains such as receipts from sale of 3G spectrum license fees
are stripped out.
While the higher deficits in FY09 and FY10 (fiscal years ending March 2009 and 2010) could be
attributed to the need for a economic stimulus, it is difficult to extend this sympathy in the
subsequent years. The FY12 budget is a case in point. The target for the year is 4.6% of GDP.
After one quarter in the fiscal year, there is little doubt that the deficit target will be breached and
by a wide margin primarily because of mounting fuel prices. According to the RBI, the slippage
on account of fuel subsidies and the revamp of fuel related customs and excise duties alone will
be close to 1% of GDP. Add to it that the YTD revenues from disinvestment have been only
INR11.5bn compared with a full year budgeted level of INR400, the overshoot in the deficit could
be significant. We expect the deficit to be 5.5% to 6% of GDP
What are the implications of worsening public finances? This fiscal stance has created tensions
for monetary management in several ways, but most notably via inflation. The RBI has been of
the view that the high level of deficit has kept aggregate demand and consumption in particular at
artificially high levels and has added to the inflationary pressures. It has also negated the effects
of rate hikes. In fact, in the latest monetary policy, This policy mix of expansionary fiscal/tight
monetary was last evident in the mid-1990s.
This is at an aggregate macro level –micro repercussions also deserve a mention. One of the key
policy agendas of the current administration has been generating rural employment via the
NREGA (National Rural Employment Guarantee Act). The act provides 100 days of employment
to one member of every rural family each year. Initially, wages for this scheme were set at prespecified
levels but more recently have been linked to inflation. The immediate impact of the
NREGA was positive to the extent that it helped in raising rural incomes and lowered rural –urban
disparities.
The programme has however, not resulted in any meaningful improvement in agriculture
productivity. The objective of the NREGA was to create rural assets/improve productivity
alongside higher rural incomes. As this is not happening at least, at a reasonable pace, the
demand-supply situation has become imbalanced. Higher rural incomes have lifted the demand
but not the supply of food
More importantly, labour shortages have surfaced in some parts of the country. Pre-specified
wages (which were above minimum wages to start with in several stages) and their more recent
benchmarking with inflation has reduced the supply of unskilled labour not just in the agriculture
sector but also in industries like construction. Consequently, wages are reportedly rising faster
than productivity and in fact, raising the risk of a wage-price spiral.
A second area of concern has been the slowdown in the investment cycle. As discussed in
previous reports, the combination of lacklustre reforms, rising cost of capital and a lacklustre
recovery in information technology related exports has dented investment activity. Our estimate of
the cost of capital based on a equally weighted average of 5 yr AAA corporate bond yields and
the earnings yield shows a remarkable rise over the last few months
The reforms process meanwhile remains weak. Even though it is likely that some measures such
as foreign participation in multi-brand retail may finally go through, the overall process clearly
lacks direction. As an example, investment in the infrastructure sector continues to be plagued by
issues like environmental clearances, unclear and impeding norms on land acquisition and
absence of coal linkages for power sector projects. Likewise, poor governance vis-à-vis effecting
user charges in the power sector have resulted in high transmission and distribution losses of
around 28%. These losses have undermined the confidence of private players in the sector.
These headwinds indicate a continuation of weak investment activity. The dismal growth of 0.4%
yoy in the January-March 2011 quarter may or may not be repeated – the point however, is that it
is likely to languish at weak levels.
What about the bright spots in the economy. Optimists have pointed to us the amazing vigour of
exports. India’s exports have outperformed those from the rest of the region by a sizeable margin.
We are however, more sceptical about the true level of export growth. There appears to be
growing disconnect between growth in exports and port traffic (Figure 5). Considering that
engineering goods and petrochemical products, the two main drivers of India’s exports in recent
months, are generally transported by sea, the anomaly is interesting. It is possible that much of
the impetus to Indian exports has come from higher prices. Even so, there appears to be an
element of overstatement. By considering purchases by Asian economies from India, we find that
India’s report exports were roughly 21% higher than those reported from India.
To summarise, the overall backdrop is one opposing fiscal – monetary policies, risk of a wage
price spiral, sluggish reforms and faltering growth impact asset prices. Solutions are of course,
available but implementing them would require political resolve. The existing track record does
not give us much reason to expect any speedy implementation.
This backdrop contrasts significantly with that in the pre-Lehman period. Apart from the early part
of 2008, inflation was reasonably contained, the fiscal deficit was correcting and there were many
more catalysts to growth. These included the advent of consumer financing, rapid growth in the
on-shore business processing and telecommunications industries. The fillip to growth from these
new activities was significant.
This deterioration is showing in a reset of asset prices. The price earnings multiple has now been
treading water almost since the beginning of 2010 and Indian bond yields have diverged from US
yields. To some extent, this divergence in bond yields can be attributed to an even poorer state of
the US economy and diverging monetary policies. Nonetheless, it would also be fair to say that
from a regional context the divergence of Indian bond yields has been relatively unique.
The same has also been manifested via a smaller surplus on the capital account. As Figure 6
shows, the surplus on the capital account has recovered in the post-Lehman period but has
settled at much lower levels. This contrasts with developments in the ASEAN region, where
capital flows have strengthened. We believe this is a reflection of the state of the economy.
No comments:
Post a Comment