Which way will the rupee go: Business Today 18th January 2015 issue

The rupee's slide from an average of 61.70 to a dollar in November to 63.51 on December 24 has been due to factors driven by both internal and global influences, as well as shocks emanating from the Russian crisis. However, the markets have taken it more stoically this time compared to 2013 as there is a belief that the balance of payments (BoP) is strong today with forex reserves of around $315 billion and that the present development is relatively transient in nature.
The Russian crisis has impacted almost all emerging-market currencies. Russia, being a major oil player, has been affected relatively the sharpest by the declining price of oil with the OPEC's recalcitrance to cut production in a bid to squeeze out shale oil production in the US. This, combined with the Ukrainian crisis, which has led to a trade embargo by western nations on Russia, has pushed it to a point of possible default, as memories of 1998 have been ignited when the government had reneged on payments. Add to this the statement by Janet Yellen [Federal Reserve chair] on the possible increase in US interest rates, which has caused funds to move away from emerging markets. The Mexican peso, Brazilian real, Turkish lira and South African rand were all impacted by this development.
The rupee's fall, though not that precipitous relative to peers, has also been driven by developments in the BoP as the trade deficit has widened in November with gold imports compensating for the decline in the oil bill due to lower crude prices. This, combined with the outflow of FIIs in both the debt and equity segments, has put pressure on the external balance, thus exacerbating the position. Funds, too, have now buffered in a rate cut by the RBI in early 2015, which would mean the Indian market would become less attractive at a time when the rates are increasing in the US and declining in India. The RBI has been intervening off and on to control this fall, but somewhere there is a feeling that the rupee should be allowed to weaken to provide a boost to exports, considering that shipments have shown signs of slowing down with the relatively anorexic world economy.
The rupee will also tend to be impacted by the global currency play where the strengthening of the dollar will continue to weaken related currencies and this is one factor over which we will have less control. The earlier theory of the real exchange rate being overvalued has diminished in importance given the decline in inflation in recent times back home.
What does it all means for us? The rupee will remain volatile until the Russian crisis eases and the direction will be upward (depreciation). Importers should be wary of such movements and hedge their positions to ensure they are not caught on the wrong foot. The RBI, which has almost taken comfort at the inflation situation, will have to bring in the exchange rate factor on top of consumer price inflation targeting when considering the next monetary policy move. It should always be ready to intervene in case volatility increases.
A weaker rupee may not quite help to push up exports, given the state of the world economy and the limited elasticity of our exports to rate changes. Imports, on the other hand, would become dearer and add to the inflationary pressure. More importantly, companies that have borrowed progressively from the ECB route will be pressurised on their repayments and debt service with a weaker rupee, more so as they have not been hedging their positions given the high cost. Therefore, a volatile rupee is a concern for the economy and the RBI is cognizant of the same.
While a rate of Rs 61 to Rs 62 looks fair under normal circumstances, Rs 63 to Rs 64 can be the short-term range, which can spill past Rs 64 if the crisis exacerbates.

Too many hurdles in way of raising top-level pay at PSBs: Economic Times January 14th 2015

The principle of market economics is that for a similar undifferentiated product, the price should be almost similar. But this does not work when it comes to the labour market, especially when it comes to banks that have different ownership patterns.

Public sector bank (PSB) honchos rightly feel that they deserve better pay packets given that their counterparts in the private sector earn between Rs 4 crore and Rs 6 crore per annum, while they settle for around Rs 20- 25 lakh. Even if their perquisites are added, the difference remains wide, considering the private sector also rewards its management with stock options.

Thomas Piketty, who is still the flavour of the season, would say that in the capitalist world, the management appoints directors who, while representing shareholders, reward the management with extravagant compensations.

In return they are provided a good remuneration with possibly a commission thrown in. If it is in the hands of the board of directors, then for PSBs, the government, as owner, has to take the decision.

But there are issues here. In the order of hierarchy within the government, PSB heads come lower than the RBI, wherein salaries are marked along with civil services positions linked to those of members of Parliament and minsters and so on. Therefore, having a unilateral increase will be difficult, as banks cannot hike the salaries at higher levels but leave those below unchanged.

It is interesting to see how the average pay varies across various bank groups and staff structures. The table shows the average compensation received by employees in various bank categories based on RBI data. Also juxtaposed is the percentage of officers in total staff.

The table comes up with two revelations. First, on the compensation side, the average pay is much higher for PSBs compared with private banks. New private banks pay less than even old private banks. Foreign banks are the highest paymasters, at almost three times the industry average.

Second, on the employment front, public sector banks have a very hierarchical structure with officers being in the minority. As a corollary, it can be said that foreign banks with a very high level of officers have virtually low support staff. This can partly be due to less paper work, given that they would be less focused on the retail side, which requires more branches, staff, and officers handling their own affairs (though there would be outsourced agencies moving coffee cups).

The average pay at banks which have zero support staff shows mixed trends. Deutsche Bank averages Rs 31.4 lakh, while Axis is at Rs 6.13 lakh, Indus Ind at Rs 5.2 lakh, Kotak at Rs 7.64 lakh and Yes Bank at Rs 8.92 lakh. Quite clearly, having less support staff tends to make it possible to compensate officers better.

These statistics raise two conundrums. The first is that if PSBs have to increase their pay packages, then they need to do so across the board, which will not be possible given that there is a large number of support staff. This may not be in the ambit of the new structure, given the lower valueadded work being done. Unions will never agree to such one-sided packages.

Is it possible that just like PSBs have taken in lateral employment for specialists and paid them private sector salaries, the same can be offered for CMD positions? But then it has to be offered across all banks, which will entail changes in compensation to all employees — this won’t work.

The second is that within the new private banks, the inequality is really stark where the difference between the topmost pay and average pay could be as much as 80-90 times compared with PSBs, where the difference is at 2.5-2.7 times. In fact, the public sector does display a very egalitarian structure in contrast.

There is some talk of getting in private sector experts as CEOs of PSBs. This will not be possible unless the pay is increased as the incumbent has to also be prepared for so-called government interference. Interestingly, there have not been too many instances of PSB bankers leading private banks except at the inception stage in the early 1990s.

This is curious as no private or foreign bank has sought to take in a PSB executive as their head. Therefore, movement appears to be doubtful both ways.

Hence, while there is a strong case for increasing the salaries of PSB chiefs, implementation will be a challenge as we would need to take everyone along, which may not be possible.

Lessons in leadership: Financial Express January 11, 2015

Winners Dream
Bill McDermott with Joanne Gordon
Simon & Schuster
Rs 699
Pp 324
Madan Sabnavis
WHEN BILL
McDermott walked into SAP America in 2002 as president and CEO, he encountered a disinterested workforce. For a person of his dynamic disposition, it was a challenge and one that he loved. He worked towards motivating the staff and reaching an impossible goal of achieving a 10-time increase in sales in less than three years. How he did it and how he managed such targets in his earlier job with Xerox form the crux of McDermott’s book, Winners Dream.
Two themes emanate from his storyline—broadly about leadership—which, as per McDermott, is about changing minds and mindsets. The first is that the customer is the most important person for any organisation and, for success, one has to work towards obtaining and retaining this entity. The second is the staff and management. A true leader is one who knows how to take them along and also provides incentives so that they work better.
The customer is always right and hence is the king. This is always a dictum to follow because, at the end of the day, one is selling a product and the buyer needs to be convinced that he is getting a good deal. McDermott’s own stories of how he managed to placate and sell photocopying machines to disgruntled people are quite interesting. This means going close to the customer and understanding his requirements, which, at times, will also mean knowing him personally.
In fact, the way McDermott describes how he set about his own business of running a deli—in a locality that had a lot of competition—is quite amazing. How does one break into such a market? McDermott adopted a simple strategy of identifying his customers and putting them in three buckets.
The senior citizens wanted home delivery, which others did not provide then. By providing this service, he captured this chunk of the market. Second, he observed several blue-collared workers dropping in while going home on a Friday, the day they got their pay. McDermott provided credit to these people for extended time, so that they came back to him. More importantly, he states that he did not have a single default in payment, as these people got emotionally attached to his deli. Third, he observed that children were not trusted in other shops, where they were made to stand in queues to get in, as there was fear that they would steal. McDermott treated them with trust and dignity, and opened his doors to them, which got him a loyal clientele.
When McDermott moved on to working with Xerox, Gartner, Siebel and SAP, this objective was always at the forefront, which enabled him to meet with success everywhere he went, including countries like Puerto Rico, which no one could believe would buy copier machines. McDermott’s motto is that it is the customers who determine whether or not any company should survive or not. The strategy, simply put for a salesforce, goes with the acronym ‘SPIN’. When dealing with any customer, we need to evaluate the ‘situation’ and ‘problem’, which are the S and P of the issue. We then need to articulate the ‘implications’ and the ‘needs payoff’ to close the deal.
Let us look at some of McDermott’s advice. First, we should know everything about what we are selling and hence, when doing a deal, should know where to stop. Second, appearances are important and hence the entire personality of the salesman matters. The way they talk, walk and give that final handshake all go into being an impressive and effective salesman. Third, one must do everything to please the customer and make him feel important. The list goes on in this way.
The second theme concerns managing and leading people. Here, McDermott shows how he focused on incentivising the people he worked with, which involved lavish holidays in fancy places like Hawaii, which helped to keep them motivated. More importantly, it got out the best in everyone, as they competed for these rewards. The belief is that if the company takes care of the top performers, they will take care of the company. The sales team was flown to outstation destinations for sales meetings to make them feel important, which also helped build camaraderie.
McDermott also has lessons for how we make a successful team and his belief is that leadership is the art of developing followership. This one is quite crisp and succinct. Build a team and have a plan drawn up for everyone. Make sure you have the best talent. Cross-pollination of talent, role-play, role modelling all go into building this energetic team. Empowering people means that you trust them. By delegating responsibility, people will do their jobs and, more importantly, perform. The clue lies in bringing about effective execution and going beyond just reporting news and instead ‘making news’.
McDermott quite interestingly sums up everything to do with successful employees with five terms: success, accountability, professionalism, teamwork and passion. These values are from his own experiences, which he has applied to make his jobs successful. This will hold for all companies and for all employees because, at the end of the day, one needs to have these qualities.
Winners Dream is an autobiography of a very successful leader who knew from the beginning where he wanted to be. His passion for leading a team and being the best got him into Xerox and his relentless pursuit for excellence took him to the top. Never missing a chance to learn and relocate, his dream of reaching the top took him exactly where he wanted to go, which is quite remarkable. Coming from a very ordinary struggling family, his rise to fame is now legendary. Though the narrative sounds a trifle egotistic, it is digested easily, as what McDermott says makes a lot of sense. Mapping your goal to its achievement with unbridled passion is the mantra to be pursued.

Let’s pause FRBM for a while: Financial Express January 7, 2015

The European economies and the Indian economy do not look similar as the former is still in the stage of stagnation while ours is on the verge of recovery. But a common theme that has pervaded the policy options exercised across these two dissimilar geographies has been fiscal prudence. The euro region perforce has to control government spending and rein in the fiscal deficit as it was the cause of the Greek crisis to begin with.
This is also a condition put by the ECB when invoking its own version of QE. The Indian government has chosen to do its own tapering in the last three years after the pump-priming programme that was undertaken following the financial crisis to ensure that growth remained buoyant. The general tone at North Block on this issue appears to have changed, and rightly so.
Government expenditure is a very useful tool for reviving an economy especially when there is a demand-side problem. Today, there is absence of demand for goods and services in India as consumption is down because households are not spending; industry is not investing as capacities are still underutilised (71% as per the latest RBI data) and the government is loath to spend as the Fiscal Responsibility and Budget Management (FRBM) norms are held sacrosanct. Such spending was applauded after 2008 when the government ran a higher deficit; but once we slowed the flow from this tap, growth, too, slowed down. Critics blamed the government for spending too much by giving away money through social programmes (the MGNREGA spent only R30,000 crore, which is 0.3% of GDP) which caused high inflation (one minister even said that inflation was high because the poor were eating more).
The policy of following the FRBM norms has been pursued assiduously and has meant that the government had to cut back on expenditure to control the deficit when revenues did not increase—especially because revenue is dependent on the state of the economy and growth, over which the government has little control. In fact, John Maynard Keynes, the renowned economist, would have said that higher government spending would have created jobs and growth through the multiplier, and investment would have increased through the accelerator (the famous Harrod-Domar model). And this was notwithstanding the fact that the money was spent on frivolous activities like digging up holes to fill them up, which the MGNREGA is almost all about. In fact, the higher incomes of rural workers due to MGNREGA had actually made them spend more on manufactured products, which added to consumer demand in good times. Now, this has stopped as people spend more on food and have less to spend on manufactured goods which are indicated in the very low growth in production of consumer durable goods for the last 3 years with growth in FY15 being negative.
The government’s role is important here because we are all waiting for consumption or investment to increase, which is not happening. Incremental pick-up will take place but then we have to wait for the cycle to turn gradually and that can take 2-3 years, during which several things can change, viz., oil prices could move up, interest rates could increase, the exchange rate can come under pressure and so on. If a big push is required then it has to come from the government and this is why there is a call for such expenditure on infrastructure.
Curiously, the same voices which are asking for more privatisation (especially of the public sector banks) and the government moving away from economic activity as it is considered inefficient are now asking for more government activity in the productive sphere. There is an anomaly here which has come up more out of desperation. The Union ministry of finance, in the mid-term Economic Review, has indicated that there is a strong case for moving away from FRBM targets and being more accommodative of expenditure as it can trigger a virtuous cycle of growth and investment. The passage of the land laws through an ordinance could be a precursor for such a move which will be beneficial for the economy. The challenge really is to ensure that it goes in the required direction as all money is fungible and it is hard to finally say which part of the money goes for what purpose.
The way it works is simple. The government is a major consumer of cement, paper, steel, machinery and electrical goods. Any infra project will need more of all these products, and with the land laws being cleared, projects can take off in the PPP mode as well as through public sector initiatives. This will lead to higher employment and demand for these back-end products primarily produced by the private sector. Such demand will revive these companies and create more demand for labour as well as other inputs that go into the manufacture of, say, steel (iron, coal, power, etc).All this will add to the virtuous cycle.
Economists like Joseph Stiglitz and Paul Krugman have always argued that policies relating to fiscal stringency should be used in moderation and have to be geared as per the overall economic conditions. The euro crisis is mainly due to the governments cutting back on spending even while keeping interest rates low. This has not helped. Japan’s case, however, does provide a counter-view, that government spending too may not necessarily help.
For India, the government should start spending but to make sure that the environment is enabling, interest rates have to be lowered, or else the private sector may not be able to keep pace with the demand. As inflation has come down, and is likely to be around 5-6%, there may be a strong case for RBI to review the target of a 4%-rate (with a 2% margin), as the average CPI inflation rate has seldom gone below 6% on a sustained basis. Anyway, earmarking 0.5% of the FY16 GDP for project expenditure, which is spent immediately, can be a chance worth taking as it will definitely help create demand at a time when global economic conditions are also favourable. Hopefully, we will see such moves on February 28.

The tunes of 2014: Financial express: 29th December 2014

The year 2014 was significant for us in India as it marked the emergence of Narendra Modi as the Prime Minister, whose persona has been taken to be the enigma of hope for an economy that has been stagnant for two years. The theme naturally was one of change, and the song Rock You Like a Hurricane (Scorpions) would best describe the setting, which was what the PM sang. We had the formation of the BRICS Bank at the global level, and sharp tones at financial inclusion (Jan Dhan), patriotism (Make in India) and cleanliness (Swachh Bharat) caught on with all celebrity corporate honchos holding the broom and being clicked on cameras even if it was for a few minutes.
Second, the focus was always to be on RBI and while there was discussion on whether RBI would perforce agree with the government which asked for lower interest rates, it held on to the rates and reiterated that inflation targeting was the way to go and the famous glide path was assiduously pursued. It was a case of saying that for monetary policy only inflation counts, and Nothing Else Matters (Metallica).
Third, the story of project clearances is now less convincing than it was in February when the earlier government said that over R6 lakh crore of investments have been cleared. This number has been increasing and after May there was news that more projects would move from the position of being ‘stalled’ and some names were also thrown in to add to the credibility. But today the euphoria on project clearances has come down and behind doors the whispers are that there has eventually been less traction here. The tune on the lips is, Won’t Get Fooled Again (The Who).
Fourth, along the way, the apprehension of tapering became a reality and the quantitative easing of the Fed has come to an end, and the expectation of an interest rate hike is now taken to be a reality. But across the Atlantic, Mario Draghi has assured of the continuation of easing and Abenomics still gives Money For Nothing (Dire Straits) and carry trade continues to flourish with money being channelled to the emerging markets.
Fifth, while the slogan of acche din is still being chanted, there is scepticism of the growth path. While 5%-plus appears to be taken for granted given the low base effect, the fact that industrial growth is crawling and unconvincing—both consumer and capital goods production growth are uneven and tend to become negative—is disturbing. More so as we are through with the so-called busy season and there has been limited traction. We Still Got the Blues (Gary Moore) and talk is already on that the 2015-16 Budget will be the game-changer—meaning, don’t expect too much during the rest of the year.
Sixth, the bright spot on the economic landscape has been the external account which has done well notwithstanding the yo-yoing the foreign inflows and the global turbulence in the forex markets. The rupee is largely stable and even the latest panic due to the rouble crisis has been less severe for the rupee relative to other emerging market currencies. The range of 60-62 rupees to a dollar  looks like the medium-term trend though variations in the short run would keep the rupee between 63-64 to a dollar. Shine on you Crazy Diamond (Pink Floyd).
Seventh, the Indian psyche never changes. RBI has been talking of increasing financial savings, and everyone is talking of giving up gold (though those propagating the same never give up their own deposits). Tough measures were taken to control the import of gold and the bill was contained in FY14. With the CAD looking good, there was talk of the new government opening up this sector—and the 80-20 rule has been rescinded already. But we all know that the Indian public can get no Satisfaction (Rolling Stones) from anything but gold, and our gold imports have started rising again in October and November which is when they should have been spending on other goods. It is not surprising that neither consumption nor financial savings have taken off—even Jan Dhan could not do so by enabling opening of 94 million accounts.
Eighth, the stock market has been as crazy and unpredictable as ever. The indices have been impervious to low economic performance.
However, the rouble crisis has hit it hard. But the stock experts keep talking of the Sensex reaching 30,000 soon and 40,000 by FY16. They would, as that is what their business is all about—it is like Dancing in the Dark (Bruce Springsteen).
Ninth, When the Smoke is Going Down (Scorpions), then what do we do? Close down institutions that have outlived their purpose? While several critics have been asking for the Planning Commission to be closed, it is happening now and soon it will be part of the socialist history.
The Commission has withstood many onslaughts including the jibe of each Plan being the same Plan for the ‘nth’ time! But what is less said is that while this institution will go, in typical Indian fashion, it will be replaced by another with a different name and a different set of experts. Jobs for the boys?
Last, the final blow has to come from the Sultans of Swing (Dire Straits) or the Arab sheikhs. How does one tackle predatory competition when someone is lowering the price? Lower them further, and squeeze them out of business. This appears to be the OPEC strategy and their decision not to cut production is a move that will debilitate the shale producers and push them out of business. Will this work or not? One has to look into 2015 and wait for the allegro to play out.
While all have savoured the slogans but not sat back Comfortably Numb (Pink Floyd), we all will get into the Act to make 2015 a better year. Happy New Year.

Calibrating data dependence: Financial Express 22nd December 2014

Data is quite interesting in economics as it can be interpreted in varied ways, leading to different conclusions and recommendations. The quality of Indian economic data has been debated extensively and while there are constant attempts made to change the base years and composition of various indices, subjectivity remains in their interpretation.
There are essentially four issues with data, two of which can be surmounted with time while the other two are based on subjectivity. The composition of any data point like GDP or IIP is a logistical challenge given the presence of a large unorganised sector which accounts for around 40% of the economy. The statistical organisations are constantly trying to bring about improvement, which is commendable. Also, where indices are concerned, the composition and base years are being changed to make them more up to date.
The other issue on data relates to revisions, as we move from provisional to final numbers. There do tend to be swings which can be misleading. But then given the structure of the economy, it is better to have some indicative data than nothing or with longer duration.
The other two aspects of data pertain to interpretation. Often this year we have ended up saying that there is a base year effect which makes the final number high or low. High CPI indices, for example in October and November 2013, tend to bring the change in the index for 2014 lower not because prices are coming down but because the index was very high the previous year. This is a clumsy way of explaining a low inflation number or higher IIP growth number (which comes over a negative growth in the last year). To partly eschew this ‘base year’ syndrome, we need to ask ourselves whether or not we are interpreting data in an appropriate manner.
Let us look at the price indices to begin with. The CPI inflation number has been moving down almost continuously from 8.6% in April 2014 to 4.4% in November and the WPI too has moved from 5.6% to nil. But at the ground level, people still complain about high inflation. This is so because lower inflation does not mean that prices are coming down, but just that the rate of change of prices has come down. Also, a lower November number does not spare the household of the higher prices being paid all through the period cumulatively. Ideally, an average inflation number for the period is more relevant, which was 7% for CPI and 3.8% for WPI.  In a way, using the end-point number for concluding that inflation has come down may be myopic as the actual burden is much higher. In fact, even the build-up of CPI inflation was 5.4%. i.e. November over March.
The IIP data is even more interesting. Monthly numbers tend to be volatile given the production cycles across industries. The seven growth rates during the year so far are: 3.7%, 5.6%, 4.3%, 0.9%, 0.5%, 2.8% and minus 4.3%. What is one to make of these numbers? At times the base year explanation is given while on other occasions we search for some reason like a closing down of a unit or a sudden order from a sector. At the ground level, we again say that nothing is happening as there is little consumption and investment demand. Ideally, we should move away from the monthly interpretation and look at cumulative growth as it irons out the monthly blips or cycles and also addresses the issue of seasonality. On a cumulative basis the growth is 1.9% over 0.2% last year for seven-month. This clearly indicates stagnation.
Curiously, one brings in the PMI too as a leading indicator when the index is restricted to a survey of non-public sector based on perception of conditions being better or worse on some parameters over the previous month. Yet there are furious attempts made to map the PMI with IIP which is based on actual numbers and it is not surprising that the two almost always deviate and similar trends are more due to coincidence of the base year impact.
Trade data, too, should ideally not be looked at on a monthly basis as there are similar issues in terms of timing of exports and imports just like the IIP where the billing and dispatch of goods could spill over. Hence, in FY15 so far, the growth rates of monthly exports (over last year) have varied from minus 5% to 10.4% while that of imports between minus 12.3% and 26.8%. The response of being good or bad ends up changing stance as these numbers are volatile. Again, a cumulative picture makes more sense as ultimately the full year numbers looks at all 12 months and not just the last month. Exports have grown by 4.9% (7.3% last year) and imports by 5.2% (minus 6.1%).
Banking data has its own interpretation as growth in credit and deposits is reckoned year-on-year. Therefore, for end-November, growth in deposits was 11.7% and that in credit 11.3%. This gives the impression that both are growing at similar rates. But such growth rates actually include data of the last year as by using November 2013 as base, four months of FY14 could distort this number. Therefore, while such an approach is in sync with, say, tracking the growth target for the entire year, a better way is to look at build up during the year, i.e. November over March-end. Doing this, the growth in deposits is 7.9% while that in credit 4.8%. Looked at this way, we are better able to reconcile the surplus liquidity in the system than if viewed on an annual basis.
With a plethora of monthly data points coming in, there is invariably a rush to draw conclusions on how the economy is behaving. There is a tendency to look at single points data which makes us miss the larger picture. Policy-makers, however, tend to look at trends, expectations and the cumulative picture before taking decisions, though it is always tempting to extrapolate single-month performance to the broader canvas, especially when they look good. This should be eschewed.

Gurus of Chaos: Investment theory: Gurus of Chaos: Book Review: Financial Express: December 21, 2014

Gurus of Chaos: Modern India’s Money Masters
Saurabh Mukherjea
Bloomsbury
R350
Pp 171
INVESTING IN shares is not an easy job. While one might like to go with the herd, it is not the best approach, because, to be successful, you need to do something different. There is a lot of psychology that goes into investing and there are some simple rules that should be kept in mind. This is the crux of Gurus of Chaos, a book by Saurabh Mukherjea, one of the best-known names in the market.
In a book like this, which carries interviews of people like Sanjoy Bhattacharya of HDFC Asset Management, Alroy Lobo of Kotak Mahindra AMC, Akash Prakash of Amansa Capital, S Naren of ICICI Prudential and the likes—and also Mukherjea’s take on how to work in the stock market—it becomes difficult to question what these experts are saying. The reason is simple: they are fund managers of repute whose funds have done extremely well and if they are telling the reader how or where to invest, they cannot be wrong. That’s where the beauty of this book lies. While these experts do not give names of companies one should invest in, you can easily pick up clues on what one should look for when looking at hundreds of stock prices. Every tip in the book makes a lot of sense.
The book is written from the point of view of a long-term investor and not a day trader. Therefore, one can think in detail about the rules given and not just go by instinct. A long-term investor is a different kind of species and displays traits that typically involve being risk-averse, sceptical and patient. He will have an open mind and, above all, be a contrarian. We need to control what psychologist Daniel Kahneman called the ‘reflex’ brain, which controls our response to external stimuli. In investing, if the ‘reflexive’ (the so-called spot reaction) brain overrides the ‘reflective brain’ (which introspects), it can lead to regrettable decisions.
The author’s belief is based on what journalist Matthew Syed has maintained: to become an expert in any field, one needs to develop at least 10,000 hours of expertise, which can mean 10 years. The process of learning becomes efficient if done under a guide and a favourable environment. Mukherjea’s starting point is that there are three tenets that should be followed at all times: intense training and research to analyse companies, intellectual integrity, and the ability to deal with greed. We need to also look beyond the obvious and meander into the realms of political and psychological aspects of the market to get a better grasp of the situation.
Mukherjea has a template with four parts, which can be used when selecting which companies you should invest in. The first is the strength of the ‘franchise’, which includes the brand, architecture and innovation of the company. Mukherjea’s illustrations are quite revealing. The longer the warranties offered by the firm, the stronger is the brand, as it gets the trust of customers. And this can’t happen unless the firm is sure of its product. Also, the age of the company and the price premium charged on its products reflect the cutting-edge of the brand. Further, the company’s behaviour with employees, customers and suppliers throws light on the franchise. Companies like Hindustan Unilever, Hiranandani, Gujarat Cooperative Milk Marketing Federation and Asian Paints stand out in this respect. Similarly, access to patents makes a difference to the brand. Also, minor aspects like after-sales service or number of distributors can tell you a lot about the company.
The second part of this picture is the quality of financial statements. Mukherjea prefers to look at the cash tax rate and cash conversion ratio to judge a company, and is wary when he sees high amounts of loans given, as it reflects interconnected lending, which is not a good sign. He also stresses on the quality of the auditor here.
The third aspect to watch out for is the promoter’s competence. We hear the management speak every year about the company’s performance. However, one should go back to what they had said the previous year and then question whether or not the company has achieved what was promised last year. In fact, the presentation of results is often done to camouflage numbers. Hence, every time there is a change in the structure, one can guess that they are hiding something.
This leads to the last criteria, which is promoter’s integrity. Mukherjea points out that in any sector, which has a lot of government intervention, like power, infrastructure, metals, mining, real estate and telecom, promoters have to circumvent laws to build a profitable enterprise. But can you trust such people? Logically, one should keep away from such stocks. This view is also shared by Akash Prakash, who has a dislike for sectors with government interference. Hence sectors such as natural resources, property and infrastructure become untouchable. Further, promoters who continuously reward themselves with employee stock ownership plans need to be watched.
Mukherjea also has some rules for buying shares, which are again based on common sense. First, we should buy in only those companies whose business we understand. Second, these companies should be in a position to generate cash flows and high return on capital for long periods of time. Third, the companies should be bought at prices that build a margin for safety. Generally, it is believed that an underpriced stock of 50% sounds good, as it can withstand a 10-20% margin of error. The author pitches for 30% underpricing to be the point of entry and gives the example of Maruti Suzuki, whose prices fell when there was labour unrest and, with this margin, did well when normalcy retuned.
Mukherjea’s final suggestions are to be sceptical, though not pessimistic, believe in iconoclasm and be a contrarian. One should not get carried away by the latest fads and be tenacious. Keep doing your research and be patient, he says. Don’t see the prices and value of your investments every day. Diversify the portfolio to avoid the risk of being overruled by reflexivity and take it easy.
Gurus of Chaos is a very easy-to-read book with a lot of common sense. With various fund managers giving advice on how to tackle the markets, you need to choose what sounds the best, there is consonance in the general approach to the game of investing in the chaotic market.

Companies must hedge forex exposure as RBI influence on currency is limited: Economic Times 17th December 2014

What should be the ideal exchange rate? There is clearly no easy answer here as there are a number of factors that go into the determination of the exchange rate starting from the fundamentals to elements such as sentiment, NDF market, RBI’s position, expectations, global cues etc.

The real effective exchange rate has often been used to define the appropriate exchange rate level where relative inflation rates are brought in and it is assumed that the market is savvy and takes into account this factor in the background. If the REER is strengthening while the NEER is static, then it is assumed that the rupee is undervalued, as the rupee should have been appreciating.

The RBI on its part always maintains that it has no view on the rupee and is only interested in ensuring orderly movement meaning if there are disruptive forces, then it acts by either talking to banks or buying currency (which is the case today). What are we to make of it?

The REER concept in a way has limitations because it uses trade or exports as weights for calculating the index. While cumulative trade amounts to around $750 billion in FY14, the quantum of invisibles was around $450 billion (receipts plus payments) and capital account was another $75-100 billion. This means a fairly large part of the balance of payments — around 40% — would not be driven by relative inflation and by other factors.

To get a closer picture of how exchange rates are being driven, the relation with changes in forex reserves can be analysed. Theoretically, exchange rate is the result of the equilibrium of demand and supply for dollars, which is indicated by the change in reserves.

Ex post, if the forex reserves have increased, then the exchange rate should have appreciated with a negative sign and vice versa. Data for the past 60 months has been used to draw an inference through a simple regression equation. The advantage of using changes in forex reserves is that RBI action also gets subsumed in this relation because if the RBI is buying dollars in the market, then the forex reserves held by it should increase, and in case it sells to stabilise the rupee, then the reserves must dip.

The results are quite revealing. First, the coefficient of correlation is quite strong at negative 0.50, which means there is fairly significant association between movements in forex reserves and rupeedollar movements. The negative sign goes with appreciation of currency when reserves increase.

Second, the coefficient of change in forex reserves is negative 0.00012, which broadly indicates that if $1000 million dollars come into the system, the exchange rate will appreciate by 12 paise. Third, the intercept, which covers all factors outside forex reserves change, is 0.32, meaning there is a natural tendency for the currency to depreciate and unless there is a very large inflow which can overwhelm this intercept, the rupee will continue to fall.

Last, the coefficient of determination called rsquare, which explains the proportion of the change in the exchange rate that can be explained by the changes in forex reserves, is around 25%. When quarterly data is used instead of monthly data, similar results are obtained with a slightly stronger relationship with r-square rising to 0.36.

All this means that while one can be searching for some order or pattern in the movement in exchange rates, they are fairly random. The physical movement of dollars is able to only partly explain the changes in the exchange rate. As a corollary, RBI intervention through physical sale or purchase has a limited impact and has to be continuous and considerable to actually move the currency.

In fact talking to banks could be more effective. This also probably also explains why the movement in the rupee does not go hand in hand with movement in FII flows. The sentiment factor definitely is critical here.

This being the case, the RBI is right when it warns companies to hedge their forex exposure as even its own actions will have limited influence over the currency and while there is a belief that the RBI is happy to have the rate between Rs 60-62 a dollar, it cannot really guarantee the same through action.

Ironically, it is the sentiment or belief that the RBI will defend the rupee either ways, which is keeping the rupee stable. With the imponderables exerting more influence on the currency they can pressurise the P&L accounts of corporates. Even the REER is a weak guide to predicting future exchange rates. Quite clearly, hedging such exposures should become a habit.

Making sense of the growth puzzle: MInt 12th December 2014

The performance of the Indian economy has been quite enigmatic in the past two-three years. Two successive years of low growth cast a shadow on our growth potential and we went around looking for reasons. Policy paralysis dramatized the issue and remained embedded in our minds. The cabinet committee on investment under the United Progressive Alliance government cleared as much as over `6 trillion worth of investment by February. Yet, growth remained anaemic. We then said that we need reforms and there was some movement on land reforms and foreign direct investment in retail. Then the central government changed. Clearances have continued and the administration has been made to take decisions. Yet, the economic situation is at best stable, although sentiment is sanguine. Are we missing something?

An analysis of the growth path since 2011-12 shows slowdown has been due to a series of issues in which the government plays only a secondary role. The main issue has been with demand, where the level of spending has come down. The three major components: consumption, investment and government have shown limited traction.

While consumption numbers have increased, it has been more on account of food items rather than consumer durable goods, which, in a way, is a trigger for industrial growth. Growth in consumer durable goods for instance was 2.6% and 2.0% in 2011-12 and 2012-13 respectively, and then declined by 12.2% in 2013-14 and further by 12.6% in the first half of 2014-15. Clearly, households are not spending on non-food items. The reason is not hard to guess. Food inflation has eroded the spending power, as Consumer Price Index (CPI) inflation has been high averaging 10.2% in 2012-13, 9.5% in 2013-14 and 7.4% in 2014-15 (up to October).

Investment has been down over the years, with gross capital formation at current prices coming down from 30.6% in 2011-12 to 28.5% in first half of 2014-15. Two reasons can explain this phenomenon. The first is that investment in infrastructure has come down which, in turn, is due to two reasons. One, the stalled projects on account of policy impediments and bureaucratic red tape and fear of future retribution and (to an extent) reduction in government spending. Two, the prevalence of high interest rates has affected the feasibility of several projects.

The second reason for the decline in overall investment in the economy is that industry has cut back on investment. This is mainly due to surplus capacity with the average capacity utilization rate coming down from 77.7% in first quarter if 2011-12 to 70.2% in the June quarter if 2014-15. Quite clearly, low consumer demand translates into lower demand for intermediate, basic and capital goods. Add to that the surplus capacity in a high interest rate environment and investment is bound to be curtailed.

The third component of overall demand in the economy—government expenditure—has been under pressure in the last two years. It will probably continue to remain constrained in the current financial year as well since revenue has not accrued as budgeted primarily because growth projections have not materialized as yet. This has forced cuts in project expenditure. Such expenditure cuts have ranged between `38,000-`40,000 crore in 2012-13 and 2013-14. This in turn, has affected industry due to backward linkages. The present stance on the deficit is to pursue the Fiscal Responsibility and Budget Management Act path and restrict the fiscal deficit to 4.1% of gross domestic product for 2014-15. Therefore, chances of pump-priming by the government are low. In fact, with the fiscal deficit already touching the 90% mark for the fiscal year in October, further cuts in expenditure can’t be ruled out.

Low growth may thus be viewed as an issue of reduced demand caused largely by high inflation and controversies that impeded decision-making. The National Democratic Alliance government has considerably improved decision-making but ground realities are yet to change.

Demand revival would be a gradual process as even though CPI inflation came down to 5.5% in October, prices are still rising and that it is only the rate of increase that has slowed down. In fact, from 2011-12 onwards till September, total compounded inflation has been close to 40%, which has hit household budgets hard.

Therefore, while governmental action has assuaged sentiment, the fundamentals would take time to turn around. Interest rate cuts will help to a limited extent as a series of rate cuts would be required to revive fresh infrastructure projects. Further, certain policies such as those concerning labour, land and environment continue to be stumbling blocks.

These cannot be addressed easily given the legislative processes and political equations. The decline in global crude oil prices has been fortuitous and extremely beneficial for the economy not just from the point of view of inflation but also in terms of keeping the rupee stable and lowering the pressure on the fuel subsidy bill. But, it is important to recognize that the government is only an enabler of growth and not a reason when it decides to follow fiscal austerity. Getting all the pieces together for growth such as consumption, investment, reforms, administration and interest rates, surely takes time.

Marginal gains from KVP: Financial Express December 9, 2014

When the intention of the government is to achieve financial inclusion, any scheme, be it the Jan Dhan Yojana, introduction of payments banks and small banks or the reintroduction of the Kisan Vikas Patra (KVP) should be welcome. However, for the success of such schemes, three factors are important, i.e., design, access and cost. Prima facie, the KVP scores well on all the three, though the final investors may be from a single cluster—those who would want to avoid paying tax.
The KVP is not a new scheme but had existed earlier before being abandoned in 2011. The reason was that it tended to become a conduit for channeling black money as the certificate-holder was anonymous and it was kind of a bearer bond. It offered a good rate of interest and there was no TDS and proceeds were taxable though there was no way to check on this. It was not meant for farmers, but the money collected was to be spent on the farm sector. In 2011, when it was abandoned, the outstanding certificates were of around R1.5 lakh crore out of a total of R2 lakh crore—nearly 75%.
The new KVP, launched in November, doubles the invested money in 100 months and offers an interest rate of 8.7%. The advantage is that the interest rate is locked-in for the entire period; and hence, in a declining interest-rate regime, the KVP holds a lot of attraction.  It can be transferred to others and redeemed earlier, after the expiry of the minimum lock-in period. The interest is taxable but there is no TDS.
Rudimentary KYC, in the form of photo, name and address is required. But there is no requirement of the PAN being furnished. However, if the amount invested is more than R50,000 (with this serving as the highest denomination), then the furnishing of PAN is required. It can also be redeemed at any post office in the country, offering ease of transaction. Will this work?
We need to look at the three classes of people who could be looking at this instrument. The first is the lower income group, especially in the rural areas, which will be the typical financial inclusion target. They are used to going to the post office and, hence, can be a potential customer. The design also looks good for them as the returns are good, there is no TDS (though this may not matter for this class), can be transferred and redeemed early. But today, they already have other schemes which are equally or even more attractive.
There are the National Savings Certificates (NSCs), which give a return of 8.5-8.8% depending on the tenure. Then, there are time deposits at post offices, which include recurring deposits that give the flexibility of shorter tenures, albeit with slightly lower rates. They earn between 8.4-8.5% interest and allow for premature withdrawal. Also, the monthly income scheme helps to save regular amounts periodically. Therefore, the KVP may not be adding significant value to the existing array of products, and unless it is marketed by the post office or bank (which will also be allowed to sell them), it may not catch the interest in this segment.
The second segment is the middle-income, tax-paying group. Such investors would be weighing the options between various instruments. The NSC, within the post office bouquet, scores high with the tax benefits under Section 80C thrown in. The PPF gives a return of 8.7% for 15 years with periodic withdrawals available after the minimum lock-in period with all tax benefits on the amount invested as well as the interest earned. In fact, for such savers, there are other tax-saving avenues like long-term deposits, LIC payments, home loan repayments under Section 80C. Moreover, there will be competition from the NSC which has a similar design. There is, however, a limit of R1.5 lakh on NSC savings and, in case an investor wants to save beyond this level, then the KVP offers an opportunity.
The third segment will be those who want to escape the system anonymously. The KVP, thus, is an effective tool for this category. The KYC norms don’t matter because, once transferred, the original name would cease to be of importance. Given that there is no TDS, one can eschew the full payments of taxes as it does not get recorded against any name with the PAN not being seeded for investments less than R50,000. The higher KYC relaxation, compared with, say, the NSC whose KYC relaxation is capped at R10,000, makes this attractive.
The fact that the KVP, in its earlier avatar, attracted many such savers means that the third category of people has been using this as an avenue to avoid taxes. When it was discontinued, there was a limited substitution between the NSC and the KVP. In fact, for the last 7 years, between 2005-06 and 2012-13, outstanding certificates were between R2-2.1 lakh crore, while post office deposits increased from R3-3.6 lakh crore.
It may be logical to conclude that there could be a tendency for this third category to show more interest in this product. It will be useful for those who would like to invest their gains from, say, sale of land, in these certificates, where their identity cannot be mapped and consolidated, given the non-requirement of a PAN. It would be laborious to hold, say, 200 certificates of R50,000 each to invest R1 crore. But for those who don’t intend to avoid taxes, there are other avenues like banks-deposits or debt mutual funds with the latter also throwing in some long-term capital gains tax benefits.
If we are looking at the KVP from the point of view of financial inclusion where the saver is not liable to pay tax anyway, with the NSC already existing, it would compete but may not be able to actually draw the saver away. At any rate, it would mean substitution and not really add to the overall kitty of savings.
The overall picture is, hence, one where it could be useful for channelling black money into investment but may not quite inspire the lower income and tax paying classes. Fortunately, there is not much cost attached to this scheme as it was done by the post offices and will be done again by them. As the postal department is hardly aggressive about marketing, there is really no push factor, which is good as there are no concomitant costs involved. To the extent that it brings in black money, it is good for the country as it resembles the bearer bonds concept of yesteryear. This could be the gain but we should not expect it to be a major tool in the small savings armoury of the government.
The good thing about the KVP’s re-launch is that, at the worst, it will make no difference. If we are able to mobilise additional funds, then it would be a big plus for the system. This is how we should view this scheme.

The Social Life of mOney: Book Review Business Standard: 11th December 2014

THE SOCIAL LIFE OF MONEY Nigel Dodd
Princeton Press
444 pages

In the aftermath of the global financial crisis, one question frequently asked is whether or not we can trust the issuer of money, which is the government. In the latest episode, the financial system, which was largely unregulated, made serious mistakes. Governments chipped in with quantitative easing programmes to bail it out. As a counterbalancing act, governments had to cut their spending on programmes that were directed at the common man. Is this fair?

In this interesting and enjoyable book, Nigel Dodd delves into the sociological aspects of money and puts the pieces together to explain why alternatives to state-issued money could be the future. He argues that the rise of internet money or Bitcoins is primarily a response to the growing impatience with the generator of money.

After all, what is money? It is something that is accepted by everyone for conducting transactions. Should this be the prerogative of the government? How do we move this domination away from governments, which have this right by law? How do we control what governments do? When individuals do not repay loans they are not spared, but when the government defaults, there are different rules.

This is the starting point of Mr Dodd's story and he goes back to the various aspects of money - its origins, relation with capital, debt, guilt, waste, culture, territory and utopia - to provide an understanding of its fundamentals.

Money emanated as a means of exchange and replaced barter that was seen more as either a plain exchange or a return gift. By valuing all goods in monetary terms, the concept of money eliminated emotion and made it a pure business transaction. The American sociologist Talcott Parsons had gone a step ahead and called money a means of "communications" since all social interactions involve communicating with one another and, because there is a price attached to every transaction, money communicated this value.

From these simple origins, money was elevated to "capital" and, here, Mr Dodd introduces a Marxist flavour to the discussion. As long as money served as a medium of exchange it was fine; once it transcended to a store of value, it was held for its own sake, which created the concept of banks and credit.

In Marxian terms, owners of capital had to get the working class to buy more of the goods created by that capital until they became indebted and ultimately bankrupt. Curiously, this theory holds very fertile ground against the nature of the 2008 financial crisis. This was precipitated when "Ninja" loans, or loans with initial low interest rates were made to inflate business, and this indebtedness led to the crash when interest rates were sharply increased because these households were unable to repay their loans.

Mr Dodd also translates the concept of money to the build-up of "debt", which once had a stigma attached to it. People wanted to be free of debt because it was associated with "guilt" and affected the social hierarchy. In the 1970s, however, the United States took the dollar off the gold standard, which meant it could be printed without limits. Ironically today, the United States has to run debt to provide dollars to the world. The growth of money substitutes like derivatives has compounded the problem as we have become overbanked. Mr Dodd calls it casino banking.

Mr Dodd discusses money from the point of view of territory and culture, too. The concept of the euro can be understood as money crossing individual "territories" and covering a larger spectrum of countries. This is probably the way to go as money in this form is no longer constrained by specific governments. The proliferation of globalisation has made it possible for borrowing across countries (euro markets) as well as derivatives that are traded across regions. The Special Drawing Rights of the International Monetary Fund was another invention that did not quite take off, but it was an example of an attempt at creating alternative forms of money. The dominance of the dollar will probably come down as more such monetary arrangements fructify.

But having common money is possible provided it satisfies the other tenet of "culture" - like-mindedness - to be accepted. The concept of the euro can also be traced to the "culture" of the participants. It was the creation of a currency for countries that were culturally aligned, which meant that they had similar characteristics that were stated as economic pre-conditions for joining the euro.

Mr Dodd also explores the value of money from the point of view of "waste" and draws in the theory of Veblen goods, named after the American economist Thorstein Veblen, which refers to goods for which demand increases as the price increases because of their exclusive nature and appeal as a status symbol. Since owning money for its own sake has become a status symbol, it is now being hoarded in larger quantities.

Given the attributes of money and the gradual loss of confidence in government control over it, it is inevitable that new ideas like Bitcoins will germinate. The United States, which has enjoyed global hegemony because the dollar is the most acceptable currency globally, has to pay heed to these new currencies that are coming up and gaining acceptance. The controversy over the United States debt default and fiscal cliff are only manifestations of this growing scepticism.