Discretionary distortion - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Discretionary distortion A  A  A

31 OCTOBER 2009

It is tempting to get swayed by the better than forecast, 3.5% GDP growth (annualised) of the US economy in Q3. Perhaps things are turning out fine, after all. They well may, but after a lot of effort. The fact is that the US, and other developing countries, and also China, have provided fiscal and monetary stimuli to help their economies grow in the absence of spending by consumers, who are, naturally, nervous after the financial meltdown. The US budget deficit is estimated at $ 1.4 trillion, nearly a tenth of its GDP. This is not a number to be sneezed at, not even if there's a lot of financial pollen in the air.

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In order to repay the mountain of debt, both domestic and foreign, the US citizen will need to save more and consume less. But the expectations are that he will consume more, in order that the Government may withdraw the stimuli it is providing. Which means that the US must find things to export to other countries and which they are willing to pay a higher price for, in order that the US citizens continue to maintain their standard of living.

Its running out of options. Before globalisation took roots, things like cars, computers and planes were the large US exports. Japan has now taken over in cars, China and Taiwan in computers and France in planes. There are new technologies, such as new solar energy farms, or nanotechnology, or robotics, which the US, with its venture capital funding and flexible labour policies allowing unviable units to shut, is especially good at developing. But these would take time.

In the meanwhile, a good part of the US GDP growth was thanks to its 'cash for clunkers' programme to prop up its automobile industry. US consumers were paid cash if they traded in old, fuel inefficient vehicles (clunkers) for new, fuel efficient cars. This has boosted auto sales, and hence GDP, but one has to see if, now that the programme has ended, auto sales rise nonetheless, or if the programme has cannibalised future sales.

US household spending is up 3.4%, the highest growth in 2 years, indicating a restoration of consumer confidence. That's good news. But then, how will households, and the US Government, pay off its debts?

So the cash for clunkers programme was a discretionary distortion and one has to see how that pans out.

Indian politicians just love discretion especially when it is in their hands. The whole gamut of petro product pricing and subsidies is a distortion of such horrendous inanity that only Kafka, other than our bureaucrats, can conceive of it! Subsidised kerosene is diverted as an adulterant to diesel, subsidised petrol encourages the growth of the auto industry leaving a potential future problem when we run out of oil, besides the environmental impact of more vehicles. A lot of the subsidy of LPG and kerosene does not reach the intended beneficiaries but is eaten away by a corrupt administration. Yet we continue with this folly.

As a result of such distortion, companies such as HPCL and BPCL, called navratnas (nine jewels) at one point in time, are awash with losses. The net profit of ONGC is up by Rs 281 crores, from Rs 4808 in Q2 last year, to Rs 5089 crores in Q2 this year, thanks only to reduced subsidy burden, which is lower by Rs 10,000 crores. It has been exempted from providing subsidy on kerosene and LPG. Discretionary distortion!

Both RIL and Tata Steel showed a fall in Q2 profits, compared to the previous year. The profit figures, say Kotak Securities, may be distorted by changing the amount of expenses that are capitalised.

Private equity firms are needing to buy insurance to deal with discretionary views on taxation! This was after Vodafone was asked to pay capital gains tax when it bought the telecom business from Hutchison, in an offshore transaction.

The root cause of such a barracuda tax approach is because of the political inability to contain spending. Schemes such as NREGS are viewed as socially desirable (they are, if honestly implemented and efficiently managed) and politically savvy. But a good chunk of the resources of such schemes are eaten up by a corrupt administration. Rajiv Gandhi had once stated that less than a rupee in five reaches the intended beneficiary. In essence then, the tax man takes unhealthy and irrational barracuda bites of honest taxpayers in order to feed a dishonest administration! And the Government looks on, and thinks of more schemes with no answerability!

Bizarre is the only word to describe the discretionary distortion practised at Air India, where the hostess, who complained of molestation by pilots, has been reportedly charge sheeted by the airline for approaching the media! What complete nonsense of corporate governance! And this is the airline that has to run to the Government to borrow money to fund its losses!

In the Ambani gas dispute, the Supreme Court judges is probing into the setting of the price of $ 4.2 by the Government! One hopes that this dispute is speedily resolved, and that KG basin gas can be properly exploited.

At the moment there are 3 things to look forward to in India. One is the exploitation of KG basin gas; it will provide a source of clean energy and it will make a significant dent in the budget deficit. Two is the spending on roads by the Ministry of Roads, Transport and Highways, and the huge economic and social impact this can have due to creation of an estimated 300 new towns each of 1 million population. The third is the unique identification number programme which will, by better targeting subsidies, reduce wastage and corruption.

It is based on these three things that one is tempted to feel that the fall in Indian stockmarkets is nearing an end. Last week the BSE-Sensex fell 914 points to end at 15896, and the NSE-Nifty fell 285, to end at 4711. The market can bounce from here, starting perhaps next week. The India story looks good and will look even better when discretionary distortion reduces.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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7 Responses to "Discretionary distortion"
Nov 5, 2009
Dear Mr Mulraj

My compliments to you for writing things in such a lucid way. As for me - I am tremendously bulish on India and Gold.

It is good that you have mentioned the reasons which i am confident of getting accomplished simply because of the potential force Indian Mass has turned into.
Vinay Shah
Nov 2, 2009
I read your articles with a great deal of interest. You've enumerated multiple reasons why the market bias will be upwards while cautioning on the potential effect of the withdrawal of Cash for Clunkers program in the US.

While there may be minor corrections on a week-to-week basis, there's a more than even chance that the market would be higher by more than twenty percent by early February.

As some of the most successful investors have said:
1. If we could time the market to perfection.....
2. The best time to buy is when the consensus is to sell; as is amply demonstrated in the comments

Keep writing insightfully

s k kundra
Nov 2, 2009
i wonder how many of your creed are left who can write fearlessly.the present rally has been liquidity driven.the markets may go up marginally next week, but will again go down.ultimately we should settel around 12 to 13 P/E multiples. the moment rbi raises roi the markets may plunge about 5% i think it is better to get out as at present and re- enter at around 13000 for real long term gains. Like 
Nov 1, 2009
I'm a regular reader of your column. The ample liquidity in the system has made the Indian Stock market rise to the level, it was at week before. It was the flow of FII money, which found the Indian Stock Market as the most dependable (comparatively) & rewarding to park their surplus, which carried our market vertically northwards in the last six months, with practically negligible or no correction.
One week's sell off by FIIS has shown how much we depend on the inflow of foreign money. The so called EXPERTS on the business TV channels, who were recommending a buy rating on specific stocks on their valuations, have started reversing their views & have started stating that the valuations are stretched in most of the stocks in the Indian market.
Xmas is approaching and these FIIS have to book profit to show the Calendar year performance to their investors, which in turn will take the market southwards.
Oct 31, 2009
The US market has to correct - the PE ratios there are absurdly high. Once that happens, US FIIs invested in India will pull out from India, because they have (their) year-end targets to meet (remember, their year-end is December, and their bonuses depend on the year-end numbers). Even without a US correction, there is a high probability that these FIIs will start pulling out. It has already started (last week), and will rapidly accelerate in the next 4 weeks (after that, a lot of their profits would have evaporated, and they will stop selling).

So hold on to yourself as the bungee rope drops us all down ...

Time to buy into good stocks?
Oct 31, 2009
Indian market is still driven by FIIS and DIIs. Retail investors are just given left overs.Many companies court FIIS and DIIs for boosting the share prices.Insider trading is the order of the day.Joker in the pack is the all financial channels with so called experts who own no shares in the their recommendations.Why not SEBi publish on line basis what shares are bought by these FIIS as partcipatory Notes, which nothing but Hedges and same ditto for DIIs. Like 
RD Patel
Oct 31, 2009
I read your weekly column with great interest. You have argued that Indian stock market may start moving up from next week on the basis of 3 important developments in India.

My humble submission is that while I agree with you in Indian developments, but flow of liquidity from abroad and status of larger economies has been playing a greater role in shaping up the market movements in India for quite some time. So much so that simply by observing the overseas markets, even a child can easily predict how the market will open tomorrow.

There is a widespread fear that if heavily oversold USD starts a melt-up, the flow of liquidity would reverse and cause a crash in the stock & commodity markets worldwide.

As rightly observed by you, US economic growth in Q3 was significantly influenced by the Cash for Clunkers scheme funded by the US Govt. So there is already a fear in the markets.

These factors also need to be taken into account.

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