Power of Globalization & Market Outlook!

In the 19^th century, the Western power colonized countries with guns, today they do it with McDonalds, Coca-Cola, Starbucks, Hollywood, CNBC, CNN, BBC, Bloomberg, Reuters, Gucci, Armani, Wal-Mart, Reebok, Adidas, Omega, Gatherer, BMW, Mercedes ; massive capital flows at high interest rates, and by doctrine that open markets will automatically lead to prosperity. 

*German ratification of ESM

*QE3 by Federal Reserve of US

*Diesel price hike by Rs5/- and putting a cap on number of subsidized cylinders

*FDI in Multi-Brand Retail, Aviation, Broadcasting, Power Exchange

*Disinvestment in four PSU’s

*Political chaos with TMC withdrawing support from UPA-2

*RBI cuts CRR by 25 basis point

*Withholding tax on interest payment of foreign loan reduced from 20% to 5%

*Rajiv Gandhi Equity Scheme to increase retail participation

*SEB’s debt restructuring of 1.90lac crores

*United Spirits in talks with Diageo

The more the world changes, the more it remains the same. Societies rise and fall; new industries come up and then fade. Wealth accumulates, only to be destroyed. People live longer, but their suffering when sick is prolonged. Wars may not be fought with huge armies facing each other in trenches but through terrorism and with trade embargoes, holding off supplies from the market (oil cartels), defaults on foreign debts, expropriations, computer viruses, etc. And while, in the 19^th century, the Western power colonized countries with guns, today they do it with McDonalds, Coca-Cola, Starbucks, Hollywood, CNBC, CNN, BBC, Bloomberg, Reuters, Gucci, Armani, Wal-Mart, Reebok, Adidas, Omega, Gatherer, BMW, Mercedes ; massive capital flows at high interest rates, and by doctrine that open markets will automatically lead to prosperity. 

We are firmly entrenched in a capitalist economic system and after the dismantling of the Soviet Union communisy economy in the 1990’s, the world is completely ingrained with a system where globalization has put forth varying degree of opportunities in terms of cost arbitrage, labor arbitrage and various other economic prospects. Indian pharma companies in the last decade started producing generics and bulk drugs for exporting to developed countries because the manufacturing cost of Indian pharma companies is around 65% of the US firms and almost half of the European manufacturers and thereby generating dollar income. Information technology flourished in the late 1990’s with the opening up of the sector which generated huge dollar earnings and employment for a different class altogether.  These sectors with skilled workforce have established our credentials in global product/service delivery mechanism.

Likewise in a globalised economy if we can export products and services to global markets then why can’t we allow global players to come with capital and expertise to set forth an efficient business model which will open up a vast array of ancillary business opportunity, employment prospect and economical shopping experience for the people of India?  FDI in retail is going to be similar to IT and Pharma which will put us one step further in league of prosperity. FDI inflows could be huge with the floodgates opening for foreign giants like Wal-Mart, Carrefour, Tesco and many others. There has been a lot of noise for opening up of the sector, but the question remains that who is shouting against it? It’s the politician who in the name of saving the common man, kirana shops, hawkers, mom & pop stores, middleman, is willing to take a political mileage by gaining vote banks.  But no one is talking about the fact that the cost competitiveness will drive prices lower and ultimately benefit the consumers in a big way. Overall employment creation could be 4 million direct jobs and apprx 6 million indirect jobs in next 10 years.

Because of various formats of retail i.e., supermarkets, hypermarkets, shop-in-shop, departmental stores, franchise model, convenience stores,  not only does the price inflation come down but it will also change the shopping experience in India. Biggest improvement will be in the retail infrastructure, i.e., logistics, warehousing etc.  At present in India one major cause of food inflation is the pilferages of the food in warehouse to the extent of 30% to 40% and this clearly indicates that how much India is under invested in its infrastructure. FDI in retail is certainly going to fill these gaps and lapses in retail and at the same time eradicate middleman in the supply chain system and bring down cost of goods with bulk purchases. All these are going to be beneficial for Indian consumers. Moreover Indian retail industry is at present a USD ~435-500 billion industry and in next ten years it will hit USD 1trillion and such a large scale market is bound to accommodate many players and small shops to co-exist.As per PWC, the Indian Retail Industry is pegged at US$ 500 billion and is expected to reach US$ 1.3 trillion by 2020. In addition, the organised retail is expected to reach 25 per cent by 2020. At present the organized retail market is almost US$ 35 billion. There are estimates that India’s organised retail market could attract US$ 15 billion in the next three years. Opportunity remains considerably big in organized retail.

In recent days a totally new economic lesson has emerged, the so called conundrum of de-leveraging by the private sectors and on the other hand huge liquidity infusion by the central banks are exerting powerful asset-price rallies around the world.  The problem with credit/liquidity driven expansion is that credit growth must accelerate continuously for the economic plane to stay aloft. The moment credit growth slows, liquidity and solvency problem arises. These are undoubtedly extraordinary times when there in zero interest rates in developed markets staying for a considerable period of time, ten year govt. yields and corporate yields are at record low level and investors have no other options except to buy equities or higher yielding assets of the emerging markets. People are searching for growth stocks and high yields and credible stories in emerging markets are finding buyers. Economic growth story has wide divergence and is unsynchronized unlike the 2002-2007 phases and every economy has a wide array of its own internal problems to deal with. Financial markets have become a considerably powerful tool in sparking hopes of revival globally and the up moves are termed as “risk-on rallies”. Fiscal cliff is the next global theme which surely the market would start talking about once the presidential elections in US is over.

In India as well capital formation has considerably slowed down in recent years specifically from the private players because of high leverages in hey days of the booming economy. And to make the matter worse, opening up of the scandals has completely shaken the decision making process of the government and the corporate as well. Coupled with it, high inflation and interest rates are putting enormous pressure on the corporate profitability. Recently with the kind of big bang reform announcements, sentiment has improved for the better and now interest rates and inflation needs to come down sharply so as to stimulate the investment cycle which will lead to creation of capacity and a revival of economy. 

All through this phase of uncertainty, one noticeable trend is the corporate India sales numbers which continuously remained elevated since 2009 despite the fact that GDP numbers are slipping thick and fast. For the corporate sales number and nominal GDP, justification could well be given from the fact that inflation remains high and so the sales figure includes the price hike. Despite of higher sales, baring FMCG and Pharma and other defensive companies, pricing power remains very low and interest burden and depreciation for ongoing projects eating into the bottomline and hence profitability steadily declined in 2011. Since the year 2000, there have been two instances when sales dipped sharply and hitting rock bottom was in 2002, 2009 and negative profitability growth was in 2001,2009 and 2011 and at the same time marking significant bottom in the Sensex during those phases. Though this time around in 2011, the PAT decline was sharper than the PBIDT despite the fact that sales remains elevated at 15% to 17%.   Reasons for the divergence are because of leverage in balance sheet and higher depreciation due to capex burden initiated a couple of years back.

It seems that the economy needed a trigger for improvement of the general business climate and last month was historic in every sense with the way the government came out with bold measures highlighted above. First the ECB and FED QE3 announcement of bond buying programme and there after the momentum carried forward with big-bang pending reforms and finally TMC withdrawing support and SP coming in was well taken by the markets and it zoomed up almost 6% in September series.

For a market trend to reverse and embark on a journey of structural uptrend requires

1. Earnings growth to support valuations

2. Liquidity to revive investment spirit

3. Yield curve to steepen

4. Current Account Imbalances starts showing signs of improvement

5. Pessimism all around with strict denial of an economic uptrend resuming

These factors encompasses all the essential ingredients of a bull market, whether a mini bull market or a secular uptrend. Till now valuations for Indian markets were below historical averages and a mean reversion trade was predominately the theme to buy under valuation and sell at a mean valuation. Secondly, liquidity remains abound with central banker’s expansionary monetary policy and Indian liquidity tightness gradually easing off.  Thirdly, Yield curve to steepen to confirm an economic recovery. At present the yield curve remains flat with no difference in short-term and long-term interest rates, is indicative of the fact that economy is experiencing a slowdown. Though we would argue that the market identifies an economic recovery well in advance but still interest rates declines should have precipitated a long way closer to the historical trough, before an economy reversal is called for and a yield curve steepening thereby indicating a recovery underway.  Fourthly, it is perceived that Current account deficit likely to improve with crude oil price correcting on fundamental grounds and import bill declining in coming months on back of INR appreciation. Finally, Pessimism all around was prevalent in 2011 when market marked a bottom around the 4500 mark in Nifty and thereafter making higher tops and bottoms. 

Now the capex cycle needs to turnaround and GFCF (Gross Fixed Capital Formation) should start building up to mark a firm recovery backed by investments and triggered by bold reforms and policy decision by the government. Pieces have started falling in place and we need to see more of it…..

Paras Bothra

Email- paras.bothra@ymail.com

Ph: +91 9831070777