A Market Mechanism For “Taxes”

While doing some research on the Special Economic Zone (SEZ) policy, I came upon this observation. The basic irritant in the face-off between India and China is the “subsidy” that the Chinese system gives to its industries……low-cost or free capital, that either come from legacy “Communist” assets, the State-Owned Enterprises (SOEs). Or the explicit subsidies that China gives to its industry, which are discretionary (ie, by administrative whim) and non-transparent. India finds it impossible to build a rule-based system that can take on such an adversary, who apparently follows no rules. Take the SEZ policy. China created these “bubbles” with taxpayer funds, that are a world of their own. The entire environment in these zones is built to please the incoming investor; existing reality can be completely wished away. India finds it difficult to build these “bubbles”, and its SEZs are bogged down by the surroundings they are situated in. SEZs in India have not taken off because politicians find it difficult to pander to the industrial investor, who may have the money, but does not have any votes……….in this trade-off, the vote-bankwallah always wins. China has no such problem. So India handed over the SEZ to private promoters. It seemed like a good idea at first, to at least get the Govt out of SEZ infrastructure. Hopefully now, promises would be kept, infrastructure would actually work, and investors would be pleased. However, 2 problems got in the way. One, private investments seek self-sustenance, ie, they must deliver a Return on Investment. Two, the feeder units to the SEZs (water, power and other services) had no incentive to deliver better quality at low cost, because they got no concessions if they were located outside. This led to a spate of broken promises, as a result of which many SEZs got themselves a bad name. The Chinese again have no problem. Not only was the SEZ constructed with Govt money (which sought no return), but so also was the support infrastructure………the whole shinbang was a zero-cost support to the incoming investor. Now here is my very hazy draft structure to take on the Chinese threat. Suppose India’s SEZ companies were given a special status, say, as “infrastructure cos”. These companies would be entitled to issue a special category of long-term (5,10,15, 20-year) bonds, whose coupon would be market-determined. Capital adequacy and repayment risk would be monitored by a market mechanism (say, the Rating Agencies). The kicker: these bonds would qualify for Section 88-type tax (deduction) benefit. Simultaneously, the PPF rate is dropped to the GOI Bonds level. The immediate consequence: PPF money would flow into these cos. Now, to sweeten this further. The Govt issues an edict saying no-questions-asked on the source of the subscriptions, a kind of backdoor Voluntary Disclosure Scheme (VDIS). Maybe 20% of the black money in the country would flow into these bonds (provided the Govt’s promise about continuity of such a policy is credible). Look at what it will achieve. Effectively, it disintermediates the Govt out of the “administer tax-allocate funds-invest in assets-build infrastructure” loop, which is very inefficient right now. Less than 10% of the taxes we pay, ends up building any kind of assets, leave alone world-class infrastructure of the kind that will keep international investors happy. All infrastructure funding is coming from the fiscal deficit, which would reduce to the extent that these SEZ cos take the burden (of infrastructure funding) off the Govt. These bonds would get traded on the secondary market, and prices would correct to the point where the yield on the bonds would be below market prices of mainstream bonds (the yield curve would get very flat, even inverted, because investors would want to delay receipt of principal). This would encourage issue of more long-term bonds, with commensurate back-to-back investment. The “subsidy” provided by long-term investors would be the “tax rate”, which would be market-determined. Since most of this money is anyway outside the tax net, the existing tax base is not cannibalized. I believe the implicit tax rate would settle around 15-20%. Given the much lower cost of collection, lesser leakages, this “tax” system would be much more “asset-efficient”, ie, much more assets would be built per unit of “tax”. And if you add the tax collections from the incremental investments into the SEZ, the tax-efficiency of this policy would be even higher. The key assumption here is that under the current tax regime, whoever can evade taxes, is doing so. This market-based structure would harness much of that money.

No commentsRead more

Acceptable Risk: Is it Worth the Reward

Risk is often understood in markets in a very limited context. In fact, classical finance treats risk as synonymous with volatility. That is NOT because it is so, but simply because Volatility is statistically measurable and capable of being mathematically manipulated, while most other elements of risk are not. In the risk-return trade-off, return is eminently measurable and managers have a good time in doing so. In any historical analysis, therefore, the return is remembered and recorded for posterity, but the risk is forgotten. So a Fund Manager may have used very high-risk strategies (that are bound to fail disastrously in the long run), hoping that his wins will be remembered (as they often are), but the risk he took will be forgotten. I have seen this spectacularly in multinational finance companies, where managers have taken break-neck risks, front-ending the returns, knowing that they would have moved on, by the time the chickens come home to roost (as they eventually will). This flawed understanding of the nature of risk leads to peculiar, and repeated patterns of behaviour among investors. For example, whenever you hand over your money to somebody else, rest assured that his attitude to risk would be less conservative than yours. Especially in case of Institutional investors. Remember: everybody’s money is nobody’s money. Investors, especially institutional investors in competitive markets, know that they are ALWAYS judged by the return they produce, NOT by the risk they took. That is why every bull market is ended by a scam or a bankruptcy brought upon by an institution taking excessive risk to produce ever-higher returns. It is an unwinnable race against expectations, which must inevitably come to grief. Rare is the Warren Buffet or George Soros, who returns investor funds because he refuses to stay in such a race. Investors worry about losing money only when they have already lost it. That is when risk (or the possibility of losing money, which is its real definition) moves to the forefront of their “hierarchy of considerations”. Till such time, they are only focused on returns. So what is an appropriate response to risk? Diversification is one, both at the level of the individual scrip and at the level of the asset class. This is where traders make their biggest mistake. Day-traders, for example, never have any Tier II capital, which is ever adequate to take care of Margin Calls in a crisis. This ability (to be Last Man Standing) itself would be a differentiator for a day trader. After all, this more than any other business, is subject to the Rule of Last Man Standing. Returns in this business are always above-average, but only as long as the investor is getting them. During a market reversal, the key differentiator is to be able to stay in the market when everyone is exiting. This is why Buffet calls his (insurance) business a “Super Cat” business, ie, he is only a temporary trustee of the market’s wealth, holding it till the market chooses to take it back during a “super-catastrophe”. So the key, implies Buffet, is not the many winning trades he makes (in the re-insurance market), but his ability to survive the “Super Cat”. He could get a smaller return on his trades, and still have a very high return, provided he was able to reduce the probability of losing his shirt in the Super Cat. The problem in such businesses is that there are not enough “Super Cats” in one man’s lifetime, to get any real sense of how much (Tier II) capital is enough. Institutional investors must take on Tier II and Tier III capital on their books (and pay for it), reducing their returns. The low-tier capital must be parked in low-return avenues, while the major part of the earnings comes from the Tier I capital deployed in the high-risk avenues. Overall, on a weighted-capital basis, the return is not outstanding. Individual investors (and corporates) have no such disability. By their very nature, they have potential access to capital (spare debt capacity, for example) which is not currently used in their mainline activities. This can serve as the Tier II capital. A high-risk trading strategy could be outstandingly successful in such a scenario, delivering hundreds of per cent in returns on a small amount of Tier I capital invested in the business. The key, of course, is not to let the tail wag the horse, and invest ALL your capital into such a strategy. The ability to draw into your Tier II capital is the key to success, not the elements of the trading strategy itself. No business can fail if it has access to unlimited capital, in a manner of speaking. Properly understood and implemented, this kind of Treasury strategy has helped build very good companies among manufacturing companies. The key is honing the ability to access capital in doses that are way out of proportion to the operational needs of the company’s mainline business. The actual asset-side investments may be in equities, bonds, commodities, forex, derivatives, even real estate. This apparent high-return asset actually derives its strength from the liability side. Sanjeev Pandiya is a private investor. He teaches Corporate Finance & Strategy at Xavier Institute of Management, Bhubaneswar (XIM-B). He also works in the private sector.

No commentsRead more

The Flawed Business of Focus

Missing the Opportunities in the Woods A couple of months back, I was sitting with one of the biggest commodity industrialists of the country, when he remarked, “We are a very ‘focused’ group. We don’t get into businesses or activities we don’t know”. My response then came as a bit of a shock to him: “Then the problem is with you (or your knowledge), not with the business.” The context was a discussion of the full range of Treasury activities that a company should invest in. The background to the conversation holds the key to the point of this piece. The company was just another (commodity) player, with good financial (management) skills, conservative management and excellent Project Management skills. In the recent commodity boom across a broad spectrum of products this company has been one of the most “fortunate”. It has grown by leaps and bounds, not only in its domestic operations, but also in exports (to China, but naturally) and in its international operations (through some acquisitions in third countries). This has triggered off a growth spree. What used to be a single-plant operation with a simple processing operation (buy inputs from one place, process, sell mostly to Indian customers) is now a multi-input, multi-location, multi-currency/ country, operation that is run by the same intellectual core of 4-6 people, who used to run the previous single-plant operation. The increase in complexity is enormous. Barely 4 years ago, the company bought all its inputs from India, and sold its final produce in the domestic market. Now, a sudden but temporary adverse movement in an ASEAN currency like the (Malaysian) ringgit, will leave a gaping hole in the company’s cashflow. Take the steel sector. Suddenly, steel companies are importing Coking Coal, Nickel, Chromium in quantities (and values) that are equal to their entire turnover a few years back. The consequent risk due to commodity price volatility is equal to their entire bottomlines today. In other words, if there is a series of adverse movements in a currency (like the Rupiah), a commodity (Nickel/ Chromium/ Coking Coal), a labour/ political problem in a country of production/ export, you could suddenly see the entire bottomline (or even a chunk of the Net Worth) of a company go up in smoke, with not a ripple worth reporting in the respective economies/ markets where the company is operating. The point I am making is this: that as Indian companies “globalise”, they take on risks that they were not paying attention to earlier (and in many cases, where they have limited skills even now). Along with risk, they are sometimes presented with opportunities from outside their “sector”. To take the steel example above, a globalising steel company is faced, willy nilly, by new threats from volatility of the currency, the commodity…… besides the normal fluctuations in interest rates and other input costs. In managing these threats, it is sometimes presented with opportunities as well. That is when it finds its traditional definition of “focus” challenged. What I heard this industrialist say, is that he would eschew opportunities that were outside the scope of his “business” and therefore not part of his focus. Risks do not seek an invitation before impacting your business. A growing company that is also globalising, needs to build skills in understanding the various risks that will enter its business domain. From the SARS virus, to the ripple effect of the tsunami, to more everyday concerns like volatile currency/ commodity price volatility, all this and more will be par for the course for the international risk manager. The flip side of this coin is opportunity. In building these skills, why does the company then turn around and say, “but our business is steel, we will only make money out of steel”. What if the next big trend is not coming in your sector. Does your Chief Economist/ Treasury Head sit back and say, “I will not make this money, because my business is steel.” The point I am making may seem obvious, but you would be surprised at how many entrepreneurs fall for the flawed argument. Like the “Devil quoting the scriptures”, companies hide behind this definition of “focus” to keep their skill-sets narrow, ie, to avoid wading into risk, to seek opportunity. A little story I heard about Delphi might help make my point. In the middle of the Brazilian (Real) crisis of 2002, the company moved nearly half a billion dollars into the bankrupt economy, betting on a turnaround. Its escape hatch: even if the economy stayed under, Delphi would find a use for the Real, by converting its liquid holdings into long-term investments. Delphi did not sit back and say, “we are an auto company”. Incidental to that (auto) business, they had to build skills in understanding the currencies and the countries they were operating in. Consequent to such an understanding, they could take a view that the Brazilian crisis would (in time) blow over, a local assessment that proved superior to the broader market’s view on the country/currency. This was a punt that worked. There are punts that don’t work. In every case, there is a fine balance that a company needs to define for itself. That is, to understand and handle the risks that it faces as part of its business, a company must build skills to survive. Increasingly, good companies define their “businesses” in terms of these critical skill-sets, rather than the product-market spaces (steel, aluminum, auto, FMCG, whatever) that these companies operate in. Is Delphi a currency speculator? No, it just took advantage of a local insight, which gave it access to superior information (and consequent) assessment. It also took advantage of a fortuitous situation it found itself in - the ability to convert a liquid holding into a long-term “investment” that would reduce the holding cost of the “view” the company had taken. The actual source of the profit came from superior risk-assessment skills, which should usually be used defensively, ie, to neutralize operating or financial risk. Sometimes, however, it can be converted to opportunity. For investors and analysts though, this makes it more difficult to understand a company’s “core earnings”. Often the market will turn up its nose at a company’s “quality of earnings”, until the company is able to prove the sustainability of such cashflows. That does not lower the strategic importance of such skill-sets. In an increasingly dangerous, integrated and volatile world, such skills (and with it, the corporate attitude) could actually be the differentiators that build great companies. Yet another argument against sticking to a defined “focus area” is that often it is subject to a known irrationality, often called Mental Accounting. This is nothing but our tendency to think in “buckets”. For example, if you make a loss in nickel buying (against a standard ‘bottom’ target price of nickel), you want to recover that loss from Nickel trading. Why? I am reminded of an American professor who would fool his natural “loss aversion” by deciding to “donate”, say, $2000 to a distant charity. Then, every time he lost money to life’s little irritants (a New York cabbie on a rainy night, maybe), he would deduct his “loss” from the amount he was to pay his charity. Somehow, he says, it makes him feel better. Try it! In line with this I argued that the company should debit a special account with all its (notional) “losses” and to calculate its Nickel cost as if it has obtained its Nickel at the lowest possible cost. Then hand over the deficit to its Risk Function, with the mandate to neutralize the deficit with “whatever means possible”. The Risk Manager could then use the company’s large cash surpluses, its substantial debt capacity and its well-rated Balance Sheet to capitalize on opportunity wherever it happens. But this would require that the company define its business a lot more broadly than “steel”. What’s more, such a definition of “business” would perforce be fuzzy, with periodic shouts of “focus” going up every time the Risk Manager miscalculates. Knowing large companies, this is a difficult, even if superior, existence.

No commentsRead more

The Power Of Compounding

I got a study of real returns in English stocks going back 300 years. What it shows is that the idea of getting wealth by being “in the market” is a fraud. Most of the 20-year investment periods produced real returns of less than 2%. Only one time - the stretch of 1980-1999 - gave investors more than 8%...with the next best more than 100 years earlier, and that still not returning more than 4%. In other words, the last 20 years of the 20th century (1980-2000) were a freak - an outlier...a “fat tail,” as statisticians call it. Of all the two-decade periods since 1700, it was the only one when an investor could have made serious money on appreciating equity values alone. Yet this anomaly misled an entire generation. Today, most investors under the age of 60 believe they need no longer work hard, save their money, or invent something new; it is enough just to “buy and hold” and they will get wealthy. Yet even in the 21st century, you still can't get something for nothing. So what CAN you do...in the real world...where real returns rarely exceed 4%? The secret is “compounding,”l. It means taking advantage of the relatively modest gains, but doing so over a very long period of time. There is an extraordinary study by Value Research, showing the advantage of beginning early. Assume an investor opens a Systematic Investment Plan (SIP) at age 19. For the next seven years, he puts, say, Rs. 200,000 each year in the account. But he stops after seven years and puts not another Rupee in the account after the age of 26. At that time, his friend gets the idea and begins putting his money into his own SIP. He puts in the same amount as his friend. But he continues for the next 39 years - until both are 65 years old. The first has put only Rs.14,00,000 into his account. The second has put in Rs.80,00,000. Who has more money? Incredibly, no matter what rate of return you use, it is the first man - the one who has contributed less - who comes out ahead. Neither man is getting something for nothing. Both are being paid for the use of their money. But the man who started first is paid more. His account always has more money in it, and he is paid more for giving it up for a longer period. Lesson: Aim for the highest, safest yield you can find. Begin as soon as possible.

No commentsRead more

Don’t Sweat. Not Yet At Least

Has the run-up in the stock markets exhausted itself? The pundits seem to think so. Mostly, the arguments in favour of bearishness come from the fact that the minds of these worthies have got ‘anchored’ to a nominal figure, like the Sensex number. “Anchoring” is one of the flaws in our thinking, wherein the mind fixates on an initial number, no matter how arbitrary it is. The situation is very similar to the pattern seen in our purchasing habits, where the shopkeeper quotes a high figure, say, Rs.1000 for a purse. This is just an initial negotiating point, which tends to become our reference point for future negotiations. So we negotiate for a discount from that initial number, even though it may have no link to the actual value of the goods being purchased. So a purse that is worth Rs.100, gets sold for Rs.800, with the buyer happy to get a “bargain” from the initially quoted figure of Rs.1000. We see this flawed thinking among those who argue that the “Sensex is too high”. Any index is a derivative, whose value is derived from the value of its underlying assets. Mostly, the argument against this has constituted of “value”, ie, the calculation of P-Es and expected growth rates in profitability. This constitutes the “fundamentals-based” argument in favour of Indian markets. There is a technical argument too. It is made up of the “big trend” towards a revaluation of currencies across the world, which will lead to a re-balancing of currency portfolios among international money managers (FIIs). In 2004, the US Dollar, depreciated further against major currencies such as the Euro, the Swiss Franc, and the Yen. The US Dollar lost even more in value against some of the more exotic currencies, such as the Polish Zloty (+23.9%) and the South African Rand (+18.1%). The other best-performing currencies against the US Dollar were: Colombian Peso (+18.1%), Hungarian Florint (+15.7%), Iceland's Krona (+15.6%), South Korean Won (+15.6%), Czech Koruna (+14.9%), Slovakian Koruna (+14.8%), and Romanian Leu (+11.3%), while the Swiss Franc appreciated by 9.10% and the Euro by 8.02%. Marc Faber points out that in Euro terms the Dow Jones declined last year by 4.5% and the S&P 500 was up by just 0.9%. By comparison, German bunds were up by 10% in Euros and 19% in US Dollar terms. So, when pundits forecast an S&P 500 level of 1,350 or higher by the end of 2005, they need to specify at which level of exchange rates the US Dollar will find itself. After all, in an inflationary environment (asset inflation), domestic asset prices can be boosted by an expansionary monetary policy, but at the corresponding expense of a weakening exchange rate. Alternatively, US monetary conditions could tighten and reduce asset inflation in stock/bond/housing markets, at the same time boosting the value of the dollar, especially with reference to the Euro. The strong appreciation of the Euro and other European currencies over the last two and a half years has led to a very significant overvaluation of the Euro against the Asian currencies, which, since the beginning of 2000, have hardly moved against the US Dollar. Whereas since January 2000 the Swiss Franc, the Euro, and the Pound Sterling have risen by 35%, 29%, and 14%, respectively, against the US Dollar, over the same period the Japanese Yen is up by just 3%, the Singapore dollar by 2.5%, and the Taiwanese dollar is down by 3%. The Euro in turn has performed strongly against the Japanese Yen and the Singapore dollar, which has led to a relatively low valuation of Asian assets expressed in Euro terms (despite their appreciation in US Dollar terms). The Singapore stock market has almost recovered in US Dollar terms to its year-end 1999 level, whereas in Euro terms it is still significantly below that level. Largely due to currency movements, Asian asset values (equities and real estate) seem to be relatively inexpensive compared to the rest of the world. Since all asset prices have risen strongly over the last two years, it needs to be remembered that rising commodity and real estate prices lead to inflation in consumer prices and so to dwindling demand. Rising interest rates follow inflation, which then depress bond and equity prices. This is what we see happening in US markets. But India and maybe Asia, seem to be much lower in the inflationary cycle. A re-balancing of currency portfolios would see a drop in Euro allocations, largely because of the technical reasons outlined by Faber above. Fundamentally too, the Euro zone does not have the growth momentum that Asia (particularly India and China) has. Portfolio flows would then gravitate to Asian currencies, with the Rupee (among others) as a major beneficiary. Given the underlying fundamentals of 6-7% expected growth, >15% growth in profitability and a Market P-E around 15, a lot of money would flow in, wanting to take advantage of relatively higher interest rates. This would create a bullish cycle, which would be self-fulfilling. Portfolio flows would ultimately serve to keep interest rates low, pushing corporate profits up and hence stock values. That would mean that a 15% increase in Sensex would seem reasonable, after it has reached a base Market P-E of 15. From a trader’s perspective, it would therefore make sense to stay on the buy side till the Sensex goes up to a current P-E of 17-18 (15% over a Sensex P-E of 15). Assuming a small 3-5% appreciation in Rupee over the short-term, a foreign portfolio manager would find it profitable to get a 10% return from Indian markets. If he gets, say, 5% Dividend Yield from a stock, no capital appreciation and 5% currency appreciation, he should be quite happy. Assuming that he gets a widely available 2% Dividend Yield and the currency return, he needs little trading incentive to invest in Indian equities. Although he might want to stay in Large Caps, and make quick exits whenever the situation demands. So it would be fair to expect that, based on the above “currency play argument”, foreign flows into India will continue, with short and increasingly sharp fits and starts. That would increase volatility, with a mean value around a current Sensex P-E of 15-18. The above argument is a theoretical one. The flaw in it is “single factor thinking”, ie, the tendency on the part of many analysts, to take a single factor and study it threadbare. The increased focus on this single factor, leads the analyst to ignore the impact of myriad other factors. Among them would be political factors, demand slowdown, corporate indebtedness/ credit cycle, etc. But to those who fear a sudden and sharp reversal of foreign flows, simply because of the increased dependence of Indian markets on them, there should be some comfort. In the current scenario, we are still not in (relative) bubble territory, as far as the international portfolio manager is concerned.

No commentsRead more

“Irrational Exuberance”

Those Words Again

Alan Greenspan is reputed to have used these words in 1995 when the Dow was around 7500.  Robert Shiller made this phrase famous with his seminal book on the ongoing subsequent irrationality.  Mr. Chidambaram recently said (in hushed tones) words to the same effect and at the same Sensex value. 

I mention this because the coincidence struck me.  We see unfolding before us almost the same story here in India.  “History does not repeat itself but it sure rhymes”.

Mr. Alan Greenspan was wrong.  The Irrational Exuberance did not stop at 7500.  Markets rose nearly 60% before falling off the biggest asset bubble in the history of mankind.

5 years and a number of other bubbles later, India seems to be headed the same way.  With bubbles blowing all over the world in Housing, in Commodities and even in precious metals, we are seeing unprecedented international financial flows.  There is media talk about the Japanese rebalancing their Asia portfolio, pulling out from China and pumping unbelievable cash into a much smaller market like India.

The logic being that the Japanese have zero cost of capital and find Indian P-Es low enough to invest.  After all, what are their options?  To buy T-Bills denominated in a heavily depreciating dollar, or to invest in the heavily over valued Euro?

It makes far more sense to invest in the world’s only domestic-led growth story, probably the only part of the world which is not part of the US-China current account deficit imbroglio.   When this structural imbalance unravels, any large investor like the Japanese banks will be left with massive portfolio losses.  India, therefore, is a safe haven – this is the logic of the Japanese flows.

But look at it from India’s point of view.  You have an excess of cash that is flooding in, funding bubbles across all sectors.  This cash will seep into other markets funding bubbles in real estate (e.g. Gurgaon and even Delhi are already running at more than 7 years income and a rental yield of 2%).

So what does poor Mr. Chidambaram do?  His small voice of sanity is hopelessly drowned in the chorus of protest from bullish investors who cannot see this party spoilt.   He is like the arrack-shop owner who knows that you need a bouncer to stop a person after his 12^th peg.  The bullish consensus and the need for liquidity-fuelled overvaluation is now so strong that there are simply too many vested interests involved.  The Mutual Fund industry, the FIIs, promoters of companies who need to make placements, and of course the public-at-large.  There is almost no one who does not have a vested interest in bullishness.

But what is the objective of the regulator?  He is supposed to aid price discovery and is supposed to cool any excessive distortions.  Is anybody in India other than poor Mr. Chidambaram concerned about the long-term damage this excess liquidity will do first to the stock market, and then after the asset bubble collapse, to the economy at large?

Let us go back to Mr. Greenspan.  He said, after the 2000 asset price collapse, that it was only possible for a regulator “to see a bubble after the fact (ie, after it has burst)”.  There have been few comments by central bankers as hilarious as this one.  With this Pontius Pilate-like comment, Mr. Greenspan washed his hands of any responsibility for what happened subsequently to the American economy.  History will not judge him lightly.

No Indian politician can routinely be courageous  (or he will not be a politician for long).  But Mr Chidambaram is at a crossroad.  Is he mustering up the courage to come down hard on almost every participant in the market and soak up liquidity through a sharp hike in interest rates or other stratagems.  Or does he let the party continue?  This may be just the start of a bubble that can take on unimaginable proportions. 

When going into the details, company by company, I can just point to a few examples of the frenzy evident in the markets:

A)   Interest rates, oil prices and auto stocks went up on the same day. 

B)   Companies which have never delivered an ROCE above 11% are today quoted at 25 times forward earnings. 

C)   Temporary spikes in earnings and cash flows are discounted into forward earnings as if they are forever.  In fact a growth rate is imbued into them. This similar to the IT Boom 2000, when valuations were based on extrapolating current growth rates to infinity.

India is not a mature economy, Indians are not mature economic players and our country simply does not have the institutional infrastructure (or even the international standing) to soften an asset-price collapse in the manner that Mr Greenspan has done.  There will be no bonds we can issue which will be picked up by willing foreigners who have a vested interest in the stability of our currency.  The consequences would be closer to East Asia (crisis) than to America.  If this trend is not arrested, I see a 1992-like situation with major bankruptcy spreading out into the retail segment followed by a fracturing of the ongoing housing bubble.

The top of every bull market is marked by scams, small and big. You can see them sprouting all over the place, simply too numerous to recount. They can come from mis-stated earnings, over-hyped news, multiple announcements of old-hat news, co-ordinated trading between institutions and operators….all of these simply impossible to “prove” except by anecdotal evidence. Recently, we saw bears getting squeezed out of a number of fundamentally weak stocks, that should be dropping in value.

This is a rare situation when the regulator needs to take an intelligent, broader view of markets. Just like the RBI intervenes in Forex markets, or like in 1996, when Mr. Manmohan Singh squeezed out excess liquidity to slow down a Capex boom; we need a move to slow down this liquidity-driven rally. 

If left unchecked, the market would move into territory where sentiment becomes a self-fulfilling prophecy. “Stock prices go up because stocks prices are going up”. Such uni-directional sentiment cannot be healthy for the markets, or later the economy.  

If the same phenomenon had been observed on the opposite side, ie, excessive and rampant bearishness, the Govt would have looked for scapegoats. Rather like it went after some brokers, merely because they had short-sold stock at the end of the IT Boom. Somehow, it is virtuous to defend “bullishness”, but it is ok to let bears be killed. This logic is flawed. Contrarians are the anti-bodies who keep the system healthy……..killing them cannot be good for the markets.

The regulator should engineer a slowdown in hot FII inflows, or make them “sticky” (maybe with an “exit tax”). This will keep hot money out, and ensure relatively longer-term investments. 

1 commentRead more