By J Mulraj

Nov 14-20, 2021

Is a short term correction due?

India’s long term growth story is good, especially if the Government continues to continue economic reforms, but its short term view is being looked at with caution, by some large institutions. The latest is CLSA, in its latest report ‘Indian Equities – on borrowed time’, points out ten reasons for believing so .  Earlier, Goldman Sachs and UBS had also so cautioned. Mark Mobius former Chairman of Franklin Templeton Emerging Markets, however, believes there is a 50 year rally in Indian stocks, as China slows down.

Among the ten reasons cited by CLSA, are high energy costs, high valuation of our stock market, compared to other emerging markets, and a likely compression of corporate profit margins.

India imports 83% of its oil requirement, 56% of gas needs and 30% of coal usage, and prices of all are rising. With fossil fuels becoming a dirty word, due to environmental reasons, capex to discover new oil and gas fields has declined. Global investors, using ESG ( Environmental, Social and Corporate Governance) norms to determine their investment strategies, aren’t funding such capex. So supply of oil is constrained. Countries like Iran and Venezuela, being under US sanctions, also face supply constraints. Demand for oil is increasing, as lockdowns are lifted. Hence prices are rising. Since India imports 83% of its oil, higher prices translate into a higher current account deficit, as also fiscal deficit, higher input energy costs, compressing profit margins, and a declining currency, which lowers the $ returns for foreign investors.

The Indian stock market is trading at a whopping 31.6 times earnings, adjusted cyclically, more than twice  the average 14.7 times for emerging markets, and significantly higher than the  22.6 times over the past 18 years. Domestic retail investors used to invest most of their savings in fixed income, mainly in bank deposits, and far fewer in equity. But with interest rates on bank deposits falling, and being less than inflation, thus eroding buying power, there is a discernible shift in the pattern of household saving, towards equity investing, helping drive up prices. Equity investing requires opening of demat accounts, as shares are no longer held in physical form, but are dematerialised. Since Jan 20, 1.3 million demat accounts have been opened every month! Still, India has only 69 m demat accounts, just 5% of its population, providing room for growth.

There can be a pause in new domestic investors pumping in money, because of factors like rising oil prices (Brent crude is at $81/barrel nearly doubled over a year) and profit margin compression, as also in foreign investors, because of higher valuations compared to other emerging markets.

Perhaps an indication of over exuberance is the drop, on listing, of the price of PayTm, which fell 27% on debut, from the issue price. PayTm was the largest IPO, raising Rs 18,300 crores. Going back in history, the Reliance Power IPO in 2008 was also the then largest, and marked the peak of the bull market. Of course, the  fall was due to the Lehman brothers collapse resulting in the global financial crisis.

Next week, two  US Trade representatives will visit India, to renew dialogue on the Trade Policy Forum, to facilitate growth in trade, which had stalled. Amongst the points to be discussed are protection of US investors, such as those of Devas Multimedia, which recently won an international arbitration award.

It is an obvious no-brainer that investors are less willing to invest if they don’t feel protected. To make them feel so, India recently pledged not to make retrospective changes, albeit after it got an adverse ruling in international arbitration filed by Vodafone and Cairn. It ought not to have made amendments retrospectively in the first place.

But, why restrict such comfort only to foreign investors, ignoring protection to domestic investors? Why are Government, regulatory bodies, investigative agencies, and the judiciary impotent in protection of domestic investors?

It is because domestic retail investors are not aggregated into a powerful body. SEBI, the regulatory body whose raison d’être (reason for being) is to protect individual investors, has been wanting. It not only failed to protect investors in several cases (NSEL, Sarada, PACL, Sahara, Rose Valley etc.) but, rubbing salt in the wound, does not distribute the little money it has recovered to the victims. It has recompensed investor victims of, eg, Sahara and NSEL, for a small fraction of the recovered amount.

Shouldn’t the Government of Narendra Modi, sworn to effective governance, step in, and ensure distribution of recovered money, which SEBI has no claim over, to victims? Or do retail investors matter not? They should, as voters!

Another example of a total disregard for domestic investors is the public issue of Amaravati Bonds 2018, which was made by the state Government of Andhra Pradesh, under the Chief Ministership f Chandrababu Naidu, to raise money to fund the new capital city of Amaravati. It raised Rs 2000 crores and the bonds were listed, with fanfare, on BSE. A state election, shortly thereafter, led to a change in Government . The new Government disowned the bonds, failed to service them. The investors couldn’t exit on the BSE either, the bonds were not traded. SEBI, which is responsible, as the bonds were listed, didn’t intervene to protect investors.

At a time when more State Governments, as also municipalities, are tapping the market, shouldn’t this issue be first resolved?

Meanwhile, in China, the mandated production cuts, due to shortage of electricity (in turn, due to shortage of coal, after a cut in domestic production was decreed by Xi, to show concern for the environment before COP26, now lifted) are having an impact. Heavy users of electricity, such as steel, aluminium, etc., faced severe cuts in electricity supply. Output of steel dropped and, with it, demand for imported iron ore. This, in turn, led to a sharp fall, (30-40%) in commodity freight rates. And, of course, global trade fell, with lower imports of ore and lower export of steel. Now that COP is over, resulting in a watering down on coal, from being phased out, to being phased down, a reversion to normalcy can be expected.

China’s bigger problem would be the falling realty prices, after problems faced by developers such as Evergrande, struggling with a $305 b. Debt burden. The realty sector accounts for 29% of China GDP, and rising realty prices have helped China pole vault to #1 position in a study on global wealth by McKinsey. In the 20 years to 2020, China’s wealth increase from $7 trillion to $120 trillion, nearly a third of global growth. But for this study McKinsey excludes financial assets. Property accounts for 68% of total wealth, in the study. So any impact in Chinese realty prices, from the Evergrande crisis, would dent its wealth positioning. And, with it, the demand for its steel and cement, in which it has over half global capacity.

Last week, the BSE Sensex dropped 431 points to end the week at 59636.

Indian investors are at the crossroad. Prudence may be advocated. Global Money supply is being reduced as central banks tighten. Inflation is going up. It seems like short term correction is due? But the long term India story remains good, especially with economic reform continuing. Now, if regulators start doing their work, and protecting investors, and the judiciary does its, and delivers justice swiftly, and not sedately, the story would be so much better.

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