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Will this 'Thatcher moment' bring Brit-like resource riches?

Mar 16, 2015

In this issue:
» India Inc. more vulnerable than ever to external shocks!
» Marc Faber expects 20% correction in Indian stock markets
» What do new guidelines mean for PSU banks?
» ...and more!

Coal mining is one of the worst examples of India's past industrial legacy. Till date, despite employing nearly a million, the sector remains mired in corruption, inefficiency, government control, trade union strikes etc. Coal India, having almost a monopoly in the sector, has been in the eye of storms for decades. The miner, being the most cash rich and highest dividend paying PSU in India, is seen as the government's blue eyed boy. It is blamed for the power starved economy's poor industrial progress. And despite successive 5 - year plans having ambitious targets for coal mining and power sector investments there has been very little progress.

The proposal to free up India's mining sector is therefore seen as the much needed breakaway from the government's tightfisted approach to controlling resources. Further the corrupt practices of allocating captive coal mines to aluminum, steel, cement producers etc. will hopefully come to an end. To begin with, the government will start allocating coal blocks to state governments for commercial mining. The move will put an end to the centre's 41-year-old monopoly over commercial sale of coal. Further, all the non-operational mines will be allocated to state governments for commercial mining and sale of coal for end use in the iron, steel, cement and allied sectors. This will bring business and revenue to coal-rich states, which have so far received only royalty from private companies mining coal for captive use. In addition, the commercial mining licenses could incentivize private sector participation in the sector. This is turn could force Coal India to do away with its inefficiencies and be more responsive to the demands of the power producers.

Why do we think such coal reforms could be a landmark event in India's economic history? Well, even developed economies have gone through such natural resource bottlenecks in the past. And efforts to free up the sector and make use of resources commercially viable have played a critical part in the nations' economic progress. For instance, as the Mint points out, in 1984-85, Margaret Thatcher won against the coal mining unions and turned Great Britain decisively toward the free market. Thus competition from private sector, transparent allocation of coal mines and commercial sale of the mineral could bring a welcome change to India's mining and power sectors.

But the government should not stop at coal reforms. It must ensure that every scarce natural resource in the economy is allocated in the most transparent manner, to the most productive players and at the most commercially viable prices. Be it iron ore or telecom spectrum, the resource riches could add several percentage points to India's GDP growth and corporate profitability. Investors should follow this sort-of Megatrend closely but invest in only those resource producers and users that have enough credibility in financial track record and management quality.

Do you think coal reform could help India break away from corrupt practices and inefficient usage of critical natural resources? Let us know your comments or share your views in the Equitymaster Club.

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  Chart of the day
High valuations in the markets is something that we have been warning you about in some of the previous editions of the 5 minute wrap up. This is because market valuations ideally are a function of earnings growth which we do not believe will be good enough to warrant recent market movements. And it is not just us. The latest one to set off alarm bells is International Monetary Fund (IMF). Apart from the global risks such as US raising interest rates and currency volatility, the markets are quite vulnerable to rising risks with regards to the health of India Inc. The picture is far from comfortable, be it the profitability or quality of balance sheet of India Inc. Infact, Indian firms, as per IMF are the most leveraged among emerging market peers. As you can see in the chart, the number of companies with worsening financials has only gone up over the years. The picture will be far scarier if global liquidity stops working in India's favour, as more companies will lie outside the comfort zone.

As per an article in Livemint, money losing firms account for 20% of total borrowings. A significant share of loans of banks has gone to the companies that are highly leveraged. While the new GDP target seems too good to be true, the performance for the latest quarter suggests a worsening of financials for Indian companies. The fact that more than 20% of debt financing for India is from foreign sources can further lead to a vicious cycle of slowdown in case there is an external shock. While Indian economy is set to witness some megatrends, not all companies are prepared to benefit from the same. Hence, investors would do well by being selective in their investments and betting on companies that are in a sweet spot, at the same time robust enough to be resilient in case the fears come true.

India Inc. more vulnerable than ever to global risks
Sample size of 2000 firms

Amidst the optimism about the new Government and the expectations of an economic revival, here is another voice warning of a correction in the Indian stock markets that you can not afford to ignore. Marc Faber, the renowned contrarian investor, economist and the publisher of "The Gloom Boom & Doom Report" expects the markets to correct by 10%-20% as the execution of reforms is likely to fall short of expectations that have been built in. If economic data is anything to go by, a real recovery is yet to be seen. The manufacturing sector is still struggling and exports are witnessing downtrend. The corporate earnings profile does not look very encouraging either. The only thing that seems to be going up is Sensex forecasts.

We will hardly be surprised if a correction follows. And would not be disappointed with the same since we believe it will offer a good opportunity to buy the stocks that are fundamentally strong and resilient to external shocks.

Given the kind of capital and asset quality stress that PSU banks are in, any kind of reprieve can bring them some breathing space. Now, priority sector lending is one area where PSU banks clearly out do their private sector peers given their reach. And it seems the government has a novel plan to help them cash in on this edge. Now, as we know, under carbon credit trading norms, companies who pollute more can buy the points from those whose emissions are less. It provides incentive to less polluting units and also helps in keeping the overall emissions under control. So the government has proposed changes to the priority sector guidelines that will be aligned to the carbon credit norms. Typically, banks are required to lend 40% of their advances to priority sectors, which includes agriculture, education and housing. But most private sector and foreign banks do not fulfill this limit given their limited reach. Many do buy securitized assets to comply with the norms. But under the new guidelines, the PSU banks could actually sell their priority sector credit to other financial entities who wish to buy them in order to comply with the norms. Not only will this incentivize the PSU entities to lend more to priority sector but also help them cash in on it. Seems like a win-win for the entire sector!

Indian stock markets ended today's day with moderate losses. Markets hopped in between small gains and profits, however, due to constant selling pressure markets ended the day in the red. BSE Sensex lost nearly 60 points while NSE-Nifty lost about 15 points. Among sectoral indices, Capital goods and Metals lost the maximum while Information Technology and Banks tried to balance the losses with some gains.

 Today's investing mantra
"Although it's easy to forget sometimes, a share is not a lottery ticket... it's part-ownership of a business." - Peter Lynch

This edition of The 5 Minute WrapUp is authored by Richa Agarwal.

Today's Premium Edition.

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