US equity indices get into lower high mode (moving away from 2021 close & January 2022 high) post strong signals from Jackson Hole meeting that inflation control is the priority of FED and that efforts would be made to achieve positive real interest rate by either pushing inflation below 4% or raising Fund rate over 4%. Given that soft landing of inflation below 4% by mid 2023 is not a high probability hope, stakeholders have now started aligning to worst case of fears where Fund rate stay elevated & sticky at upper half of 2-5% against previous expectation of softening at 1-3.5% by mid 2023! While FED is under pressure to get inflation down to 2-4% by mid 2023 guiding Fund rate over 4%, there’s no clue on managing negative outlook on growth and sub-optimal capacity expansion & employment, keeping alive fears between risk of stagnation and worry of recession. So, when macroeconomic dynamics are in rising interest rate regime against negative growth, there’s no game for being overweight on equity risk while investors prefer short duration debt/fixed income investments to avoid capital erosion from equity investments!

S&P outlook for end of 2022 is not optimistic when significantly below 2021 close 4766 and 2022 high 4817 while in trend down mode at 3650-4350 (keeping most play around 4000 ahead of rate hike event) since guidance from Jackson Hole pulling mid June 2022 low 3636 into the radar. It’s possible that 2022 goes behind delivering YoY negative return of 15-20% giving away most of the gains of 2020-2021 with close not far away from 2019 close 3230 (but above 3636) for around 12% gains for 3-year cumulative period of 2020-2022! While US equities have lost heavily in 2022, it’s no better on long-duration debt capital market with 10Y yield up at 3.15-3.50% against 2021 close of 1.5% and 2019 close of 1.9%. It’s no better on shorter duration 2Y curve with lift from 1.57-0.73 (2019-2021 close) to 3.5% by end 2022!

What’s the impact from infusion of extraordinary fiscal stimulus and ultra-dovish monetary policy?

On an end to end basis through 2020-2022, investors have nothing much to gain from equities while incurring capital erosion on debt investments. And it’s worse on macroeconomic factors – high inflation, growth contraction, bloated FED balance sheet and low consumer confidence on the global economy. In the meantime USD Index moved up from 96-95.60 (flat in 2020-2021) to 110-111.50 up by 15% in 2020-2022 aligned to higher FED Fund rate and covering for widening interest rate differential with major currencies. When inflation is on the rise and economy in downturn, Gold should have triggered safe haven bull run, but trending down from 1828-2070 (2021 close – 2022 high) finding support at strategic base $1685-1720 with positive return over 2019 close $1517, up by 13% for 2020-2022.

All combined, overdose of fiscal & monetary stimulus from US & developed economies caused severe damage on inflation without being catalyst to growth & employment while cost-benefit of economic-financial impact doesn’t add up to creat value for investors. While it ends up as zero-sum game for 2020-2022, what next in 2023-2024 is nightmare, building uncertainties around end of rate hike cycle (where & when?) and bad choice to choose between stagflation & recession. It has gone to an extent that set up of recession to help softening of inflation is seen to be the best expectation to end rate hike cycle in Q1/2023 for shift into rate cut cycle in Q4/2023 for better 2024, both for global economy & financial markets.

What’s is India context in 2020-2022 from impact of external sector and could it be better in 2023-2024?

India equities have outperformed most of rest of the world in 2022 and 2020-2021 cutting across pandemic phase & turn to reversal of accommodation. Nifty up from 12168 (2019 close) by over 40% for 2020-2022 and 2% to 6% for 2022 over 17350 (2021 close) with assumption of 2022 close at 17650-18350. While Bank Nifty lagged behind in 2020-2022 (nursing NBFC-NPAs linked wounds) with around 20% gains over 2019 close 32161, and around 13-17% for 2022 against 2021 close 35481 assuming 2022 close at 40150-41650. It’s good that investors ended up getting above par returns (over 10% annualised) from equities despite going through tough phase of pandemic in 2020-2021 and monetary tighten cycle in 2022!

On the debt capital market, it’s back to status-quo, current Repo rate of 5.40% same as that of 2019 close rising from 4% (effective operating rate of Reverse Repo rate at 3.35%) since May 2022, start of rate hike cycle. It’s been a roller coaster volatility on 10Y yield during this phase down from 7.5% to 5.75% in 2020-2021 and up at 7.65% in 2022 preparing for year end close at 7.15-7.25%. It’s kind of zero-sum game for passive & long-only investors through 2020-2022 while making highly profitable on duration play.

USD/INR play during 2020-2021 is normal moving up from 71.35 to 74.35 at annualised 2% depreciation despite heavy dose FPI inflows from excessive offshore liquidity. The change of monetary policy dynamics in the US in 2022 pushed INR down by around 7.5% while providing comfort of sub 4% annualised weakness for 2020-2022 covering for India-US interest differential. Having lost against USD (by over 7.5% in 2022), INR has gained against EUR by 7% (84.65 to 79), by 9% against GBP (101 to 92) and 15% against JPY (0.65 to 0.55). The outlook of USD/INR for rest of 2022 is not beyond 78.50-81.50 (high probability close at 79.35-80.65 while retaining appreciation phase against major currencies. It’s win-win set up for all stakeholders with good balance between depreciation & time value on USD, while those carrying liabilities on major currencies have stand to make windfall gains and worse for companies that have export receivables invoiced on EUR/GBP/JPY.

What’s the India take-away from 2020-2022 and the outlook for rest of 2022?

When global economy is in cross roads between stagflation and recession, offshore investors have sailed through safely – getting best out of 2020-2021 and losing out on 2021-2022, while it turned out to be different for India – super gains in 2020-2021 and above par returns in 2022. The rest of 2022 outlook covers 125-150 bps rate hike by FED lifting Fund rate to 3.50-4.0% while RBI is expected to hike by 35-60 bps lifting Repo rate to 5.75-6.0% during the 2 meetings to go before end of 2022! The said outlook is adequately covered with US 2-10Y yield curve at 3.50-3.35% and India 1-10Y yield curve at 6.35-7.35% (allowing for squeeze at 6.65-7.50% seen as worst case scenario).

Where from India derives the game changing advantage and risk factors?

India optimism leading to outperformance in Q3/2022 is from (a) shift in Brent Crude outlook from $100-135 to $65-100 (b) USD strength close to the peak with USD Index set to lose sustainability beyond 108.50-111.50 (c) less worry on India achieving positive real interest rate without pushing Repo rate beyond 5.75-6.0% (d) growth-inflation staying positive without building risk of stagflation or recession with FY23 GDP growth outlook above 7% and inflation below 7% while woes around twin-deficits set to get better in FY24.

Risk factors to India optimism are largely from the external sector (a) FED pushing Fund rate beyond 4% in 2023 if inflation remain sticky above 6-7%. (b) combination of rate hike and Quantitative tightening would drastically reduce quantum of FPI inflows (c) recession in the West would be negative for India exports & investments adding pressure on rate markets (d) geopolitical risks & resultant volatility on Brent Crude.

So, all combined it’s cautiously bullish outlook in India financial markets while developed economies struggle to balance between stagflation & recession making fiscal & monetary dynamics complex & unfavourable!

Good luck….

Moses Harding

Spike in US long term yields will make it tough on cost of capital & debt leverage…

US 10Y Treasury yield is up from 0.35% to 1.60% (0.32% to 1.62%) between March 2020 and March 2021, and it’s not over as yet with pull bias into 1.60-1.85-2.0%. During this phase FED Fund rate got pulled down from 1.0-1.25% to 0-0.25% as follow-on to easing cycle since August 2019 lowering policy rate from 2.25-2.50%. Impact of zero interest policy (ZIRP) regime on the macroeconomic fundamentals is not yet visible – moderate impact on output & employment and upside risks on inflation. What Next on FED actions on policy rates is not very clear: will it be extended pause in ZIRP beyond 2021 or push FED Fund rate below 0% to pursue Negative Interest rate policy (NIRP) regime if GDP growth expansion is not to desired levels or get the focus back into 1.0-1.25% to contain inflation? Most expectation however is on end of easing cycle for pause in 2021 with zero visibility on 2022.

During this phase, India 10Y benchmark yield eased from 6.50% to 5.75% in alignment with sharp reduction in operating policy rate from 5.15% to 3.35% since March 2020, adding momentum to easing cycle of June 2019 lowering Repo rate from 6%. There’s better clarity in the Indian context – expectation of extended pause in policy rate at 3.35-4.0% and retention of overnight rate at lower end of LAF corridor around 3.35%. While there’s no case for Repo rate hike in FY22, when CPI is seen to stay steady at 4-6% (and average of CPI & WPI at 2-4%) till achievement of (beyond FY22) GDP growth stability at 6-8% (helping to contain fiscal deficit below 4.5% of GDP), 10Y yield pull bias will be for shift of comfort range into 6.15-6.50/6.85% in alignment with India-US 10Y yield spread resistance at/below 4.50-4.65%.

What Next on shift into FY22 is straightforward… Excess system liquidity will anchor overnight rate around Reverse Repo rate as RBI continue to pump in liquidity from combination of OMO, spot USD/INR purchases and Buy/Sell swaps. So, worst case spike in short term rates is 65 bps as and when operating policy rate is moved up from 3.35% to 4%. Given that RBI is stuck with ensuring stability on ₹ exchange rate and medium/long term bond yields through rest of 2021 (till near completion of FY22 market borrowing), cost of working capital will be affordable to borrowers. On the other side, demand-supply dynamics will continue to exert upside pressure on 10Y benchmark yield beyond 6.15-6.25%, intermediate zone of unwind from 5.75-5.85% to 6.55-6.65%, while not seeing risk beyond 6.50-6.65%, where buy & hold interest would emerge shifting appetite from equities to Gilts & investment grade corporate debt. So, all combined, interest rate dynamics will remain supportive to growth (for output & employment expansion) and investment (for capacity & value expansion). Will FPIs like Gilts when 10Y yield spread around 4.5% when USD/INR at lower end of 72-77?

USD into value normalisation is good for INR to ensure price stability to accelerate offshore inflows…

USD Index DXY collapse from 103.50-105 to 88.50-90 (103.96 to 89.17) between March 2020 to January 2021 is followed by resilience at 88.50-91.50 (around 90) with pull bias into 93.50-96.50 (around 95). It’s comfort that multi-year big-picture of 88.50/90-103.50/105 stays intact & valid. Most cues continue to favour USD including the safe-haven status, shift from Gold to USD from end of rate easing cycle and turnaround in growth from contraction to accelerating expansion against muted inflationary pressure. So, good to assume short term upward bias at 90-95/96.50, and not ruling out extension into 96.50-103.50 (for stability around 100).

USD/INR in the meantime got pushed back at 72-77 from 77.01 to 72.27 (between April 2020 and February 2021), and would have gone down deep into 68.50-71.50 (around 70) had not RBI added over $100 Billion between March 2020 to February 2021 to its reserves, which is at striking distance of $ 0.6 Trillion. Given the robust capital account flows and RBI’s huge appetite for US Dollar, there’s no problem in establishing ₹ exchange rate stability when the going is good. But could get worse if headwinds from external dynamics get stronger and FPIs get into pause or reverse mode on India appetite.

What Next is mixed on ₹ exchange rate but would be better than interest rate outlook, if FPIs stay neutral on India. Will FPIs find India debt attractive when 10 year yield spread down from over 5% to below 4.5%, and worse when 1Y spread against 10Y is negative – inverted curve! So, as always, the tussle is between FPI and RBI. While it’s not difficult for RBI to absorb excessive $ inflows, it’s tough to handle simultaneous demand from FPI pullout and importer’s panic entry. It gets lumpy when dollar demand far exceeds supply from both importers & FPIs – set up of so-called “lead & lag” play, making USD as scarce commodity. The hedge strategy, therefore is not to stay overexposed either way, good for exporters when 12M at 78.50-80 (spot above 75) and for importers when 12M at 75-76.50 (spot below 72.65), which would help RBI to administer USD/INR exchange rate stability at 72-75. Given that FPIs appetite would be between risk-neutral and overweight, there’s no need to panic not withstanding USD strength against majors, and taking optimism from elevated interest rate and growth optimism.

Will surge in commodity prices in general and Brent Crude in particular be show stopper…

Brent Crude bounce back from $15-25 to $65-75 from start to end of FY21 can’t be ignored when it gets heavy on CAD and inflation. More so, when big-picture focus is sharply up from $25-60 to $50-85 with direct impact on consumers – high probability of petrol & diesel price shooting up beyond ₹100! Will Central & State Governments reduce tax with alignment to GST maximum tax structure to avoid pushing prices beyond 100? Can the system absorb higher fiscal deficit & market borrowing from this tax reduction? Higher Brent Crude price along with the need to allow orderly depreciation on ₹ exchange rate emerge as major irritant while in pursuit of double-digit GDP growth expansion in FY22.

It’s good that Gold has been in back & forth mode between March 2020 & now – up from $1450-1465 to $2065-2080 (between March & August 2020) before down now at $1685-1700. It’s good feel when the volatility got restricted within set big picture. Gold started losing safe-haven appetite from fiscal stimulus driven economic capacity expansion, high probability of end of rate easing cycle, bounce back of USD Index from base 88.50-90 and no major risk on inflation. Gold push back below $1765 is negative shifting short term focus down at $1450/1585-1765. Will lower price increase import of Gold to make it heavy on INR?

What’s impact on India equities from external headwinds and cross winds from domestic dynamics? Will comfort be derived from high probability of double-digit growth expansion?

NIFTY (spring back) re-rating from March 2020 low 7511 to February 2021 (all-time) high 15431 defied everything – some call it dream come true and beyond expectations (when it surpassed start of 2020 high 12430) while many see it as insane when not reflective of real economy. But, the reality is that combination of fiscal stimulus & abundant liquidity at abnormally low rates did push monies into equities, which is fine but will it sustain overtime?

Bank Nifty spike from March 2020 low 16116 to February 2021 high 37708 (through 2020 high 32613) is more surprising when Indian banking sector had to absorb pre-Covid NPAs (from NBFC sector) and post-Covid hit on productivity, profitability and efficiency – all combined, heavy on EPS. Despite lack of optimism, Budget2021 provided relief on credit pickup (from combination of productive investments and putting monies in have-not’s at the expense of elevated fiscal deficit) and news of Bad Bank & DFI approach for capacity expansion in infrastructure and high sensitive sectors for generation of consumption & employment. It gets heavy beyond 32650-37650 when there’s no clarity as yet on NPAs (inclusive of moratorium book) and profitability (ability to restore FY19 standards).

What Next on India equities is most complex? While comfort remain from US equities, looking up from next round of USD 1.9 Trillion of fiscal stimulus and double-digit India FY22 GDP growth expansion, concerns also play dominant role, both external and internal. Risk from external sector remain from Brent Crude (into $70-85), US 10Y yield (into 1.65-2%) and USD Index (into 96.50-100) and not so from domestic cues with outlook on price stability on 10Y yield at 6.25-6.50% and so is on USD/INR at 73.50-75.

Given the existence of cross-winds and lack of clarity to have decisive directional bias, it would be good to stay fleet-footed, and avoid staying overweight either way – long or short! While hope & optimism remain that 2021 high will be surpassed (with NIFTY target beyond 17350 and Bank Nifty towards 50000), there needs to be resilience at 2020 close & 2021 low (NIFTY at 13596-13981 and Bank Nifty at 29687-31264). It’s good to assume short term consolidation for NIFTY at 13596-15431 and Bank Nifty at 31264-37708 – see over 50% probability for upside break if India macroeconomic turns better to counter external headwinds.

To conclude, the best of fiscal & monetary stimulus is behind and anything more will be stretched & counter productive on the financial markets, making the asset bubble bigger! It would need swift turnaround in growth to redress issues around capacity expansion and fiscal deficit. So, need financial markets to get aligned with real markets in rest of 2021/FY22. There’s hope & optimism, but failure of delivery to expectations will be disastrous…stay with caution & prudence!

Good luck,

Moses Harding

There was no option for the Finance Minister but to “bite the bullet” to allow significant overshoot in fiscal deficit as % of GDP (beyond FRBM tolerance zone of 2-3.5%) when in risk of FY21 RE likely to spike into double-digit (now pegged at 9.5%). When into such a precarious situation from banking sector & Covid pandemic impacted contraction in GDP (FY21 GDP pegged at -8%), Budget2021 focused on higher capital & revenue expenditure, while being optimistic on revenue collections & disinvestments, pegging FY22 BE of fiscal deficit at 6.8% of GDP with road map towards 4.5% by FY26, review of FRBM tolerance zone at 4.5-8%. Be that as these may, conviction to present a growth oriented budget to ensure output expansion & job creation despite the devil’s advocacy of implementation risk factor is laudable.

What are positive vibes in Budget2021?

Budget2021 priority on “Health & Wellbeing” post-Covid is in order, with coverage around systems, nutrition, water supply, Swachch & Swasth Bharat, clean air, vaccines and scrapping of old vehicles, but the pleasant surprise is from 137% increase in budgetary allocation for FY22 at ₹2.24 lac Crores against FY21 at ₹95 lac Crores.

The emphasis on manufacturing sector is critical when India is in the mode of attracting companies that are exiting from China to elsewhere. It’s also important for India to gear up for domestic production for substitution of imports. Given these requirement, higher focus on AtmaNirbhar Bharat – PLI (Production Linked Incentive) scheme was looked for, and got modest allotment of ₹40K Crores for FY22. Emphasis on textiles with launch of Mega Investments Textile Parks to boost exports is good for SMEs and job creation.

Focus on infrastructure is on expected lines with marginal expansion in National Infrastructure Pipeline (NIP). It’s good that infrastructure-build will be multifaceted approach: (a) creation of institutional structure to attract co-lenders from financial institutions (b) monetisation of cash flow generating & other assets by NHAI, Railways, Airports etc., and (c) enhanced capital expenditure allocation in Central & State budgets. Relaunch of infra focused DFI is on expected line, with token allocation of ₹20K Crores as capital with ambition of building credit portfolio of minimum ₹5 lac Crores in 3 years. Launch of InVit and REIT to promote & attract debt flows into infrastructure and real estate didn’t have the desired results from domestic investors, and now being opened up to FPIs to attract offshore liquidity is step in the positive direction when foreign investors look for yield pickup assets in emerging assets.

It’s on expected lines to see jump in capital expenditure with 35% increase to ₹5.54 lac Crores in FY22 and additional ₹2 lac Crores to be available from budgets of State Governments. The capital-spend across road & highways infrastructure, Railways, Urban, Power, Port, Shipping, Waterways etc will help to build virtuous cycle between output, employment, consumption and wealth creation.

Banking sector stability is one of the key demand from stakeholders post NBFC-led NPA woes and capital-starved PSU banks. The demand for set up of “Bad Bank” is addressed by set up of ARC-AMC combined entity. The intent & criticality of recapitalisation of PSU banks is conveyed through allocation of ₹20K Crores for FY22, and set up of infra focused DFI & opening up of foreign investments in InVIT/REIT are big boosters for banking sector.

What are the concerns?

To avoid high FY22 BE on fiscal deficit at 6.8% of GDP (below FY21 RE of 9.5%), Budget2021 has pegged disinvestment target at ₹1.75 lac Crores and ₹12 lac Crores of market borrowings. There’s fear that FY21 deficit could overshoot into 10% inclusive of ₹80K Crores borrowing in rest of Q4/FY21.

Risk mitigation to be under 6.8% on fiscal deficit is to outperform in FY22 GDP growth with expectation pegged at 10-12.5% against lower base of FY21 contraction of around 8%, with the need to quickly surpass GDP top-line output to over ₹200 lac Crores to be in pursuit towards ₹350-400 Crores by FY26 for $5 Trillion economy, which is essential to achieve ambition of 4.5% fiscal deficit by then.

What could be the reaction of global rating agencies and foreign stakeholders on upward shift of “normal” on fiscal deficit from 3% to 7% when it’s not “given” that GDP growth could sustain above 7% till FY26? Need to believe that rating agencies will not react with downgrade, impact of which cannot be wished away. When in high dependent of foreign debt & equity capital, need to retain investment grade rating with neutral to positive outlook. When interest rates are set to harden making medium/long term borrowing costly, can’t afford to have destabilising exchange rate dynamics.

All combined, concerns remain from elevated fiscal deficit (struggle to avoid overshoot), confidence level to achieve double–digit growth, RBI’s ability to manage price stability in interest & exchange rate markets and last but not the least “bolt from the blue” from global rating agencies. So, undertone is mix of caution & optimism with belief that worst is behind and the best is not far away!

What’s the impact on financial markets?

Major beneficiary is the banking sector getting all that was expected – Bad Bank, DFI and recapitalisation to cheer up PSU banks. Given the top priority agenda of sector consolidation, private sector banks will gain valuation – either as suitors or ready for merger. It’s not that all is well as concern remains from post-Covid NPA/PCR and and now new problem from market risk on investment portfolio as 10Y benchmark yield shift play from 5.75-6% to 6-6.25%. Impact on P&L from combination of higher credit cost and m2m provisions can be heavy on PAT/EPS. While long term outlook on Bank Nifty is good, no clarity as yet to get bullish on short term till Q4/FY21 financial results are behind, but there’s high level of confidence that strategic base stands shifted from 20350-20650 (of September 2020) to 29650-30000 (of January 2021) and have no clarity for staying invested above 32650-33000.

Nifty price short term stability is better at 13500-15000 but have no clarity on breakout bias either-way. Undertone remains on buy dips mode while 13500-13650 remain safe and risk-light position at 14650-15000.

It was advised to stay away from fixed income/debt markets in anticipation of 10Y benchmark yield upside break at 5.75-6% which is done now, but need RBI’s solid support to retain play at 6-6.25% to absorb borrowing of ₹80K + ₹12L Crores from now to end of FY22.

It’s tough for investors to decide where to put monies – equities (when at all-time high valuation) and Gilts (when the worst is yet to come) when short term rates are at low. It’s toss up between staying on to low yield (without capital loss) or stay invested for combination of external liquidity & domestic growth driven valuation. Both options have for & against rationale, hence investment decision need to be based on risk appetite and reward comfort – in short, being prudent and not in greed when in cross roads!

Best wishes & good luck for rest of FY21

Moses Harding

Expectations are huge with hope & optimism – need nothing less than “extraordinary” and “out of the box” to push sentiment euphoric with “wow” feel… Will FM deliver?

India needs top-line GDP output to sustain above INR 200 lac Crores in its aspiration & pursuit towards $5 Trillion (INR 350-400 lac Crores) economy, double from current level. Unfortunately FY21 output will be down below ₹200 Trillion from pandemic/lockdown impact on economic activities and loss of livelihood, with estimated output contraction of 8-10% or so, which is not insignificant – equivalent to combined fiscal deficit of the Centre & State Governments! Economy in suboptimal capacity usage/operations is the worst position to be in, while dreaming big! So, Budget2021 need to focus on being catalyst to economic activities to set up base for significant expansion in the years ahead. It’s not rocket science to conclude that the exchequer needs to focus on combination of (a) capital expenditure for investments in economic & social infrastructure (b) revenue expenditure putting more monies with have-not’s for consumption (c) invest in banking & financial intermediation sector, strengthening their capabilities to provide leverage on equity. Impact from this combination will lead to generation of more jobs and higher consumption & wealth creation, thus breaking out from current vicious cycle to building virtuous cycle of accruing benefits to all stakeholders of the economy.

It’s easier said than done when receipts (inclusive of disinvestment) are not enough to meet expenditure, to be in borrow for consumption mode. Capital expenditure continue to be dependent on market borrowing with low or negative returns from past investments. Worst is that such high dependence on market borrowing has steadily moved up into ₹15-20 lac Crores (inclusive of Centre, State and off-balance sheet) around 10% of GDP. It’s also belief that this number would have been worse if taking into account deferred payments & refunds. This kind of financial (trap) set up is not enviable when the expectation is for dream-come-true kind of Budget!

Good to put money where the impact is the most on employment & diversified consumption

In the Covid-pandemic phase, sectors that are badly hit by lockdown look for sustainability & continuity support from the Government, which has been directing monies towards lower end of the pyramid, to the have-not’s for sustenance and the MSME sector that generates employment in the unorganised sector. The budgetary focus needs to be on wholesale – funding infrastructure, manufacturing, real estate and the banking sector. All combined would be beneficial to the unorganised sector and the have-not’s

Government can’t do it alone when the need is huge! It would need beyond pushing the Centre’s fiscal deficit from FRBM’s tolerance zone of 2-3.5% to 5-6%, and all-combined number at alarming 12-15% of GDP. It’s fine if leads to higher revenue receipts and beneficial in the long term. Government need to work on support from offshore investors – direct FDI investments in systemic important sectors/businesses and participation from others in debt & equity capital market financial structures that would emerge from the GOI as sponsor. It’s also possible to tap into RBI FC reserves which is now over $500 Billion, perceived to be idle & negative yield asset. So, combination of foreign capital and use of FC reserves is the way to go to meet the huge demand for investments for output expansion and employment generation.

Game Changer is the revival of Banking and financial intermediation sector

Banking sector participation for providing debt leverage to capital is at its low, when demand for credit is high. There are hardly few banks that have appetite for high value & high risk sectors that are systemic important to achieve what is said above. Worse, participation from private & foreign banks is very limited, and those that were active are into backstage, nursing the wounds of aggressive play during 2013-2019. Given that bank credit as percentage of GDP is well below par standards, there’s huge upside that could be emerge as spark/trigger to push India GDP output from ₹200 Trillion to over ₹350 Trillion to make the ambitious $5 Trillion economy to reality by 2024.

Resolution on strengthening the financial intermediation sector is not straight forward – need combination of Bad Bank to relieve the banking system from NPA burden on their balance sheet by taking away zero-yield credit risk linked asset book, recapitalisation of PSU banks providing desired growth capital, opening up the private sector category to cash-rich NBFCs with proven track record and finally reinstate of sector specific DFIs to fund infrastructure, real estate, manufacturing, asset reconstruction etc building co-lending or risk-participation with commercial banks. To do all these together and at the same time will need strong belief on the existing untapped potential, and obviously with Public-Private-Foreign participation – it’s tough but not difficult! It would need combination of TARP kind of approach to deal with non-performing assets and helicopter-drop kind of debt delivery to create higher level of performing assets to achieve win-all proposition to all participating stakeholders.

What to look for from Budget2021 to feel good? Do remain in hope that post-budget sentiment will not be disappointing or unpleasant…

GDP growth BE for FY22 could be anywhere at 12-15% compared to RE of FY21 contraction at 8-10%. This is good feel to take GDP top-line/output beyond that of pre-Covid March 2020, end of FY20. While attention will be on fiscal deficit estimate (expectations around 6% of GDP on revised tolerance zone of 3-6%) and extent of gross market borrowing to be pegged at ₹15-18 lakh crores (against previous ₹12 lakh crores), which is high at 7-9% of GDP. It’s good that global rating agencies and foreign investors will see elevated fiscal deficit & higher market borrowing as one-off event and essential for infusing life & strength into the real economy. The comfort is derived from expectation of surplus system liquidity and low interest rate regime through FY22.

What’s expectation on post-budget impact on financial markets?

Given that corporate tax rate cut to 25% didn’t yield desired results when system went into suboptimal capacity mode, there would be expectation of personal tax rate cut below the super-rich category, those in sub 30% tax category. It would be out of the box to keep it revenue neutral by balance of impact between corporate tax payers (with marginal hike) and relief for those personal tax payers in below 30% category.

It’s price stability in FX and Money Market, taking comfort from RBI two-way administration to prevent excessive movements both on interest and exchange rate markets. USD/INR would get the benefit of higher FDI & steady FPI flows and higher premium to keep forward market in $ supply mode – lead & lag play of exporters & importers. There will be pressure on short term money market rates cutting down flows into R/R counter, but RBI would standby to ensure order, when GOI borrowing is high and the need to manage without disruption.

It’s wait & watch in the India equity market which has outperformed beyond expectations despite warnings from powers that be of disconnect with the real economy. While liquidity impact of FY21 will get diluted, it would need strong recovery on the real economy to keep undertone positive through 2021. So, it is tough call on directional bias of equity market, but comfort exists that bias would not be into extremes – euphoria or despair!

Good luck and take care…..

Moses Harding

It’s lot to do with low cost abundant liquidity and improved macroeconomic sentiment – benefits to few top line companies while most stocks lag behind….

The recovery momentum in developed & emerging markets indices since post-Covid March 2020 lows is amazing and most didn’t expect upside break of pre-Covid all-time high of February 2020. What’s most surprising is the retention of upside bullish momentum despite being in untrodden territory, holding on to “buy on dips” appetite by pushing the base higher in “2 steps up & 1 step down” mode, establishing sustainable uptrend journey. It’s for sure that fears of the past is put behind to keep the present in optimism from the confidence on the future. Companies that are comfortable in capital & cash with absorbing capacity and those in health care, pharmaceuticals & essential services sector got benefited, while most others got badly hit. What could be the triggers to set up the trend for the future on those that gained the most and those that lost significant value?

Is the worst behind on output contraction and unemployment? How far could Central Banks stay on expansion of monetary stimulus? Is it easy to stay on course of extended fiscal stimulus? How to expand investment-consumption dynamics for recovery of lost economic value between start of 2020 to end of 2021? Need to find answers to these questions.

It’s mixed expectations on GDP growth for Q4/2020 and H2/2020. There’s comfort that contraction of Q2-Q3/2020 is behind and into expansion mode from Q4. But, this is high dependent on revert to “business as usual” economic activities, pushing impact of Covid & lockdown behind and brining the vaccine into reality. At this stage, there exists conflict in preference between life & livelihood with most suffering from lockdown impact, pushing Governments into dilemma of choosing between the two. It’s worse on Emerging & developing economies where the fiscal bandwidth gets squeezed beyond tolerance. All combined, while there’s better comfort on worst of 2020 is behind, there emerges risk of uncertainty on achieving top-line capacity of end 2019 by end 2021.

Most Central Banks in their pursuit to support growth and to arrest deceleration in output expansion took extraordinary monetary measures pushing policy rates to as low as it could, lead by G7 Central Banks keeping short term borrowing rates around zero to negative. This was followed by balance sheet expansion through asset purchases and infusion of liquidity into system. The combination of abundant liquidity at low interest rates provided the relief for significant upside to financial markets and establishing turnaround on capacity & employment. It turned good for Emerging markets supported by higher inflows from (fair-weather) Foreign Portfolio Investments. It’s so far so good. What Next? Central Banks ultra-dovish monetary policy stance is understandable when risk on headline inflation is low from demand-push and supply-squeeze factors, and what if when system gets into business-as-usual consumption mode making higher demand for investments and credit? So, it’s safe to assume that the best of monetary policy stance of most Central Banks are behind with transition into pause-mode till end of 2021 with shift to balanced stance between growth-inflation in 2022 before start of tightening monetary stance, both on policy rates & liquidity in 2023. Risk to this outlook is from extended Covid impact on the global economy, pushing the need for shift of FED Fund rate from above zero interest rate phase to negative interest rate policy regime. This outcome will set up gloom & doom in 2021 diluting the low cost liquidity impact on financial markets. The Indian context is different – RBI walked the extra mile despite in headwind dynamics from elevated inflation and fiscal deficit – headline inflation above MPC tolerance zone of 2-6% and fiscal deficit above FRBM tolerance range of 2-3.5%. So, the above-said risk factor will have the worst impact on the Indian economy & financial markets if the turnaround gets delayed, notwithstanding the hope from “make for India” (less dependent on imports) and “make in India” (for higher exports) themes.

The extraordinary fiscal stimulus support from the Government of developed economies did emerge to limit damage on the global economy and livelihood through balance sheet expansion of Central Banks from asset purchases & currency printing, thus expanding M3 money supply to arrest deceleration in consumption at the expense of compromise in fiscal prudence. What if Covid-impact turn from bad to worse beyond 2020 through 2021? Can Governments of developed & emerging economies turn loose on fiscal position against lower base of GDP? This risk factor can’t be ignored at this stage, hence good to be cautious when in hope of growth expansion for full recovery of 2020 contraction.

Given the limited bandwidth of Treasuries and Central Banks, what would support to achieve optimum capacity utilisation from higher consumption and what could lead to accelerated spending? The initial push need to be obviously from public sector push on investments & consumption. Governments need to invest and spend more on economic & social infrastructure, revive real estate sector and put monies in the hands of have-not’s who are either un or under employed with struggle to make both ends meet. It’s tough task for Governments to achieve this outside fiscal deficit, and need innovative & out of the box solutions to make it work. There’s absolutely lack of clarity on how it will be achieved.

Indian context is high dependent on Banking sector stability and appetite for credit risk

Banking sector reforms are under way – consolidation from M&A transactions, higher promoter holding for private banks at 26-40% and allowing large & well-run NBFCs with clean compliance & governance track record for conversion as a Universal Bank. It’s good that RBI has addressed the (post-Covid) issue of capitalisation of private banks when valuation of most banks crashed below 50% of all-time high. It’s prudent to provide the first option to promoters rather than going elsewhere when risk capital is scarce. So, increase of 15% cap to 26% is in order and more to regulated & well diversified entities upto 40%. This expectation was covered in 12th September banking sector report as trigger for value re-rating of (second-line) private sector banks outside of Big4 (HDFC/ICICI/Axis/KMB) and have seen 60-75% rally since then. The resolution around old generation private banks has begun with DBS-LVB reconstruction (writing off Tier 1 & 2 liabilities) and it’s possible that NBFCs aspiring for Universal Banking license will be pushed to achieve consolidation and to bring old generation private banks into mainstream that are now small with regional focus. While consolidation among old & new generation private banks will go smooth, it’s important to infuse life into public sector banks, that are already down at 12. Lots have been said about recapitalisation of public sector banks and woes around compliance & governance and productivity & profitability. It’s job half done if early resolution is not achieved given the combined PSU banks market share of over 50%.

RBI is made to shoulder management of huge government borrowing without market disruptions and to ensure adequate flow of credit to systemic sensitive borrowers. While Government has extended credit underwriting support, RBI provides cost efficient liquidity through TLTROs. This support can’t remain for long and Banks need to perform the role of financial intermediation to the satisfaction of (borrower) stakeholders and to be catalyst for output expansion and employment generation. Having addressed the way forward from adequate capital infusion, banks should now gear up to resolve issues around productivity & profitability and compliance & governance. Given that time is of essence, need to be prepared to fund economic capacity expansion in 2021 and into FY22 & beyond.

What’s the impact on macroeconomic fundamentals and financial markets?

The top-line stocks have gained the most from fiscal & monetary support of Governments and Central Banks, while mid & small cap stocks are significantly below 52 week & all-time high. Large cap stocks have derived the benefit from liquidity for easy entry & exit. The phase since end of Q1/2020 is more of short term (liquidity driven) rather than long term buy for hold (economic value) play. It’s important to be watchful on upgrade in economic value (of stocks) and dilution of liquidity & rate advantage for medium to long term investment philosophy. At this stage, achieving stability at all-time high will be from hope of extended liquidity support through 2021 and with optimism that GDP growth of 2022 shall be established above top-line of end 2019. What about emergence of conflicts between elevated fiscal deficit and sticky elevated headline inflation? No clarity at this stage to this make or break event risk, hence leave it aside for now, marking this as big risk factor in play.

US bourses have lead from the front with all equity indices comfortably settled at all-time high preparing for great landing for 2020 despite existence of risk from Covid pandemic. India is not far behind thanks to accelerating FPI inflows – Nifty comfortably over 2019 close & pre-Covid 2020 high and Bank Nifty in catch-up mode moving towards 2019 close. What Next bias is mixed between consolidation above pre-Covid February 2020 high or extended rally in 2021 before push-back for stability above 2019 close. What’s the upside target and the reversal point? Need to mark one step at a time, watch Twitter handle for direction. For now, buy on dips is the way to go!

It’s been fantastic return for 2020 in US Treasuries and AAA/AA assets and Emerging markets & India not far behind. It’s extraordinary & one-off, hence not to expect similar kind of return in 2021 & beyond despite in extended rate-pause mode. Even a rate cut in 2021 will be seen as negative building higher credit risk, hence it’s safe to assume that best of value appreciation in debt/fixed income assets is behind, and at best could be carry-trade play in 2021 – funding long term bonds from short term borrowing, being extra cautious on mark to market NAV. This outlook would emerge as headwinds to other asset classes.

USD Index lost over 10% in 2020 from 103 to 91.50 followed by recovery failure below 95. The outlook for rest of 2020 & into 2021 is mixed between 88.50-93.50 and 90-95 with most play expected to be at 91-92.50. EUR/USD upside break at 1.1650-1.1850 building steam towards 1.20-1.2150 was the script but see no cues to set focus beyond 1.1650-1.2150. USD/JPY got pushed down from over 110 to below 103.50-105, but don’t see cues as yet for extended weakness below 100-101.50 and into sideways mode at 100/101.50-105/106.50

Despite USD weakness, soft interest rates and uncertain macroeconomic outlook, Gold failure from over $2000 into $1750-1850 and unable to retain safe-haven appetite is good for big picture comfort on financial assets, while Brent Crude recovery momentum at $35-50 is in order from shift of economic capacity from contraction to expansion. Will it lead to shift of tolerance range from $35-50 to $45-70? If yes, India need to be prepared for managing direct impact on exchange rate and indirectly on fiscal deficit and interest rate. It’s good to keep this in mind for investment decision.

Conclusion: No luxury for complacency and limited room for optimism, hence being cautious and neutral is the way to go…

Despite 2020 being an extraordinary year inflicting heavy damage on the global economy, financial markets have done well across asset classes. There’s no guarantee for repeat performance in 2021 when the economy is in crossroads. The first target for comfort is from hope of achieving end 2019 top line GDP by end of 2021, visibility of which will get clear by early 2021. Till then, financial markets will ride an extended uptrend with high probability of losing steam around end of Q1/2021 preparing for value adjustment – whether it’s up or down is the unknown devil or the joker in the pack!

Good luck for rest of 2020…

Moses Harding

Note: This is follow-on report on Banking Sector Outlook of 12th September 2020 with buy & hold recommendation – it has been good gains on market cap of index stocks with better Price to Book value, since then.

Woes from NBFC crisis and its worst impact on the banking sector in 2019-2020 is seen to be behind from gaining speed on consolidation

It’s obvious that optimism on the economy is built on strong foundation of the banking sector. This got reflected in the economy from falling FY20 GDP growth momentum below 5% and overshoot in fiscal deficit beyond FRBM tolerance point of 3.5% of GDP when into banking sector crisis in 2019. Most banks got into struggle for capital & operating profit – hit by rising credit costs, pushing lending operations to back seat. Most banks didn’t have bandwidth to lend to economic & systemic important sectors that got majorly hit by NBFC crisis – infrastructure, real estate sectors etc., and those few with muscles to absorb risk didn’t have the desired credit appetite – playing conservative & safe game. The ball was pushed to Mint Street and North Block with SOS cries!

First, Government recognised the need for recapitalisation of PSU banks, but opted for going for consolidation to reduce headcount, which is down from 27 to 12 during 2017-2020. The agenda was to infuse capital only to those banks that have high probability of success. It’s also obvious that participation from PSU banks need to be very significant to strengthen the banking sector for credit support to the economy for output expansion and employment generation. I will leave this point here with belief that work-in-progress is at good speed on recapitalisation and upgrade of compliance & governance standards in PSU banks to ensure that 3 pillars of productivity, profitability and efficiency are restored to emerge at par standards with peer private banks.

The headcount of private sector banks in universal bank category is 22 as of end March 2020 with mix of new generation banks (licensed after 1991 economic liberalisation) and old generation banks, which are regional & boutique in nature despite being in universal banking category. GOI & RBI had tough time in managing failures and compelled to bring in PSU banks for resolution. Thankfully, this process at the expense of exchequer & taxpayers monies has come to an end, making (Tier 1) equity investors & Tier 2 (bond holders) to do the sacrifice to extent of balancing the weight of liabilities to realisable value of assets & value of the operating infrastructure.

Game changer moves from RBI Governor Mr.Das with blend of innovation and courage to bite the bullet

The first stroke of SBI-YES Bank reconstruction invited lot of criticism as most couldn’t see the logic, rationale and higher probability of success behind this move. The reconstruction deal made Tier-1 equity investors to take the sacrifice from dilution of value to ₹10 (of face value ₹2) while completely writing off AT-1 (perpetual) bond investors. This action of preferential treatment to equity holders got debated at length, but RBI went by the rules – terms of subscription of AT-1 bonds. The initial success of this transaction is from removal of trust deficit from depositors & creditors, turnaround in financial performance and improvement in balance sheet – all combined, stability in stock price at 12-15 (above the follow-on issue price of ₹12) and looking good for more!

Now, the second shot of DBS-LVB transaction is of different kind – merger with an unlisted bank and newcomer as an universal bank having launched its WOS behind SBM Bank. In this transaction the sacrifice got extended – Tier 1 capital written down to zero and so is Tier-2 bond listings. The sacrifice terms is worse than SBI-YES, but couldn’t be helped when the size is small and the hole is big. I am sure it’s win-win for DBS and depositors & employees of LVB. What’s in it for DBS? It’s an inorganic option to expand presence in South India where the regional connect is high with Singapore. Beyond increase in branch headcount, I do not see great value for DBS from acquisition of LVB’s operating infrastructure – technology, products & services and manpower.

What’s the take-away for stakeholders of the banking sector?

It’s fair that the intent of RBI is to protect the interest of depositors to cut emergence of trust deficit at the bud before getting blown up as systemic issue. The next is to avoid capacity contraction from closure of branches and loss of employment, both directly & indirectly contribute revenues to exchequer. While it provides good comfort to depositors, employees and the Government, it’s not correct to stay complacent, given that the sacrifice can extend beyond Tier 1 & 2 if such instances arises and the hole gets bigger. It’s also caution to smaller banks with market cap of below ₹10000 Crores to avoid high risk – high reward play & over indulgence in unsecured lending.

While Government has cut PSU banks headcount to 12 and likely to consolidate into single-digit during 2021-2024, private banks (in universal banking category) also needs consolidation when boutique category has emerged in the form of Payment Banks and Small Finance Banks, and products specific asset-finance NBFCs. It’s important for UBs to have reasonable balance sheet size and good valuation for capital raising efficiency. Now, only 6 private banks have market cap of over ₹50000 Crores, and consolidation phase need to be led by the 6+1 top-quartile banks (HDFC/Kotak/ICICI/Axis/IndusInd/Bandhan and DBS) to position private sector banks to complement with public sector banks which is poised for accelerating performance in this decade.

While the emerging reconstruction model is the way to go, the success depends on post-acquisition execution having acquired without financial sacrifice. It’s kind of good feel for yours truly that similar kind of deals was executed by SBM Holdings of Mauritius in 2017-2018 in its Kenya foray. First, acquisition of Fidelity Commercial Bank for launch of SBM Bank (Kenya) Limited writing down Tier-1 investments to $1 and absorbing branches, employees and operating infrastructure. Second is mix of financial & operating structure transaction where “bad bank” was left behind with Chase Bank under Liquidation and “good bank” was acquired by SBM Kenya along with most branches, F&P employees, technology and products & services. The pain point for depositors was from sacrifice of 25% of outstanding deposits which is left behind with bad bank. Kenya Central Bank did participate in both transactions retaining the liquidity support for certain period of time in alignment with post-acquisition profitability projections. The biggest difference here is that RBI’s financial sacrifice in these first of its kind transactions (after Centurion Banks transaction of 2002-2003) is zero and limited to that of an investment banker while keeping the transaction good for acceptance to the suitor. It’s job well done which should pave way for consolidation on its own giving priority to continuity & sustainability rather than staying in the race!

Conclusion:

Resolutions of Universal Banks (both public & private) and getting them ready & effective for economic capacity & output expansion is the priority with focus on robust balance sheet, adequate capital and desired credit appetite. While there’s better comfort on bottom-line efficiency, top-line growth will get visible in Q4/FY21 before gaining speed in FY22. The beneficiaries will be the leaders in the upper-half, who shall gain value from now on. The zoom-in focus is lit on SBI, PNB, BOB, BOI, UBI and Canara Bank in the public sector category and HDFC, ICICI, Axis, Kotak, IndusInd and Bandhan Bank in the private sector category, all positioned as suitors in the game of consolidation. Recovery of valuation of banking sector that began in the second fortnight of September 2020 shall remain in force building momentum from start of 2021. It’s tough to set targets, but 52 week & all-time high is pulled into the radar!

Good luck for the great run!

Moses Harding

It’s extraordinary for a CEO and executive head of the Governing board to hold reins for 25 years – from start up to taking to the peak, leaving peers far behind across all parameters (financial & non-financial) and stepping down in glory pushing the bar higher to $1 Billion quarterly PAT in Q2/FY21, less than a month before his retirement at 70 years. It’s envy for most as few get to attain this kind of glory, and not seen any in the banking sector! It’s important to analyse (as case study), how it was made to happen for others to follow!

What are the 5 critical challenges of the CEO that was managed to perfection?

1. Balancing regulatory prescriptions and shareholders expectations:

It’s the most difficult job given that dynamics operate in opposite direction – shareholders expect high returns come what may while regulators emphasis on risk, compliance and governance, which comes in at the expense of higher cost of compliance and diluting earning per share. Balancing the expectation of regulators without significant dilution in shareholders returns (dividend & market cap expansion) is the art that Mr. Puri practised & mastered all through! I don’t have to dwell in detail on these, as figures speak for themselves on wealth creation for shareholders (enterprise value up from ₹5 Billion to ₹6.5 Trillion since 1995) while being on the good books of the regulators (no major penalties or strictures for non compliance or deviations) establishing fair & prudent play and practices.

2. Setting high standards of customer experience with best-in-class products & services and cost & time efficient delivery standards

HDFC Bank established nice blend of products & services, customer delight and Go2Market efficiency. While most banks operated on “Customer is the King” value statement, he opted to choose products capability & delivery standards to establish customer delight as customer pull & retention strategy. When there could be very little differentiation on banking products & services, the art of packaging for cost optimisation emerging as holistic service provider was exploited to the full. HDFC Bank is far ahead in taking advantage of technology driven product innovations, that’s reflected in quantum leap in customer base, multiple hooks on each customer and alignment (of not manufactured products) with other manufacturers & service providers, taking the fullest advantage of partnerships & alliances, avoiding any kind of irritants in the relationship. It was possible for him to establish win-win relationship between customers and various business units. He went on to establish that customers don’t come for love or loyalty to the bank, and gets attracted towards product & service efficiency & wiling to pay premium for the upgrade from customer satisfaction to customer delight.

3. Retaining good talent – what’s more relevant is alignment of HR to brand & delivery standards and not to the boss

Human Resource plays the most critical role starting from strategy visualisation (story line) to building tactics (script writing) and ruthless execution (production). The head plays the most important role in ensuring that all in the pipeline deliver to perfection. The practice of the following was evident: (a) hiring best talent and not known talent, which means that there’s zero compromise on integrity, competency and commitment (b) trust & confidence on business and functional leadership which cuts across mentoring, guidance, monitoring and empowering the team leaders to get the best out of their teams (c) establishing best of talent for managing customers and revenues – team leaders & members that are the make or break team and comparable to the lower part of the human body – the hip (team leader) and the legs (feet on street sales force). If the lower body fails to perform, upper body – head (the CEO) and the torso (business & functional leaders) goes redundant, while performance of the lower body is dependent on strength of the head and torso. More importantly, the theory of people remain for the boss and not for the company got disproved in HDFC Bank.

4. Management of peer group pressures and competition

Here is where, the differentiation was built between HDFC Bank and its peers to the extent that none stay close to HDFC Bank – be it public sector giant SBI or systemic important private sector banks ICICI & Axis Bank. How it was achieved? One is from delegation – monthly performance responsibility to Team Leaders and quarterly monitoring to business leaders, while retaining responsibility on the yearly target commitment to the board, while spending more time on matters beyond 1 year. This helped to stay ahead of the rest in terms of staying updated to changing environment & dynamics, and positioning ahead of the peer group – there are number of instances that HDFC Bank was already half-way while others for preparing for the race. He never believed in temporary & unsustainable glory, and opted to wait & buy time for permanence. During a personal chat long time ago in 2005, he mentioned that he wished to build HDFC bank with natural beauty without any artificial makeover boosters, so that in rainy days the beauty glows & gets better and stands out while others look ugly from wash out of the heavy make up. How true, it turned out to be in September 2020, when HDFC posted record quarterly profit in post-Covid phase crossing ₹7500 Crores of PAT against previous ₹6500 Crores, only Indian bank crossing $1 Billion quarterly profit after tax! HDFC Bank is set as the role model for banks on growth, profitability and efficiency parameters, and it’s no surprise that most failed to deliver the Aditya Puri way when the going got tough in 2019-2020, while HDFC Bank got going!

5. Capacity Building for growth sustainability

Most businesses get caught on higher base effect to maintain continuity & sustainability in growth parameters across top & bottom line and cost-revenue. It would need combination of organic & inorganic way while emerging as combination of commercial & investment bank. This is where Aditya Puri took the best from Uday Kotak who built value for the bank doing beyond financial intermediation and establishing businesses complementary to the Bank that are light on capital and risk-weight, thus providing better Return on Asset and EPS. HDFC Bank went on to stand tall both on financial intermediation (use of capital) and financial services (non-credit products & services without use of risk-capital) building best-in-class valuation multiplier over EPS and Book value. While organic growth is made to be business as usual, judicious option of inorganic growth was adopted to beat the higher base effect. Inorganic acquisitions comes with uncertainties and risk, and would need level head & high level of business prudence to make it successful, which was done to the perfection ensuring to avoid duplication and adding to customer base that would improve cost-revenue to beat higher base effect on the bottom-line and profitability. There’s no other bank that has delivered efficiently running simultaneously on both the tracks – organic and inorganic growth!

What’s the take-away for Indian banks to have more such banks in the banking sector

Aditya Puri established HDFC Bank as the role model to emulate not only for Indian Banks but also for banks in the developing economies of Africa. More importantly, it was made to look simple as what it needs is prudence & common sense and passion & commitment, and it’s an art and not rocket science! It’s personal pride for me that I have travelled through 25 years of new generation private banking phase of 1994-2019 along with him and had the opportunity to run as peer during the start-up phase of IndusInd Bank in 1994-1999 and business interactions in 2001-2003 at the time of merger of Centurion Bank with HDFC Bank and thereafter in 2003-2007 building relationship between HDFC-IndusInd Bank!

It was great to have known you Mr. Puri and here is wishing you good health and all the very best in your new ventures!

Best, Moses Harding

US equities regain bullish undertone with solid recovery from lower end of last mile range

It’s three weeks away from US Presidential election and despite setback of Trump diagnosed as Covid+ and debate with Biden not going great, hope of more fiscal stimulus did the trick triggering recovery momentum. DJIA last-mile focus at 26500-29500 (August to Trump 2.0/Biden 1.0) stood good with back & forth moves at 26534-29199-26537-28676, and shifting to upper-half play at 28000-29500 on run upto Presidential election, while S&P held at 3250/3300-3550/3600 (3284-3588-3209-3482) looking good to punch new all-time high. NASDAQ focus was held at 10000/10675-12000 post the value correction from high 12074 which held at 10519 followed by over 1000 point rally to 11581 building steam for 12000-12074. All combined, undertone is not fatigue despite being close to 2020 high, and what more to ask for when 2019-2020 set for positive close despite worst hit from Covid pandemic on the real economy – squeezing output & employment!

India equites got the benefit from US tailwinds and now gets catalyst momentum from beyond expectation liquidity stimulus from RBI

When NIFTY back & forth at 10800-11800 was seen as extraordinary recovery, RBI stepped into make it dream come true for extended push into 11800-12300 with pull bias into 12168-12430 (2019 close & 2020 pre-Covid high). It’s indeed sigh of relief to many to be at striking distance of 12K (high at 11938 up from 10790). What Next? Undertone looks good when supported at previous resist zone 11650-11800 pushing towards 12300-12450. Is momentum good beyond 12430 when RBI expected to stay supportive beyond FY21, given that it’s not easy to push FY22 borrowings despite relatively better fiscal position? There will be sound bytes on disconnect between real economy & index valuation, despite not being evenly spread out, but deafening roar of liquidity flood emerge as the silencer. So, it’s extended party time in the near/short term with low visibility on medium/long term, which can be handled later – now open the bottle!

Bank Nifty emerged as darling of the investors in this phase with amazing recovery at 25232-20404-23904 (dot from the set bounce back zone 20400-20750) and looking good for 24611-25232 for extension into 25350-26350 but need big-bang measures (Bad Bank and promoter holding cap lift from 15% to 40%) for closer look at 32161-32465 (2019 close & 2020 high). What Next? Shift from 19500/20400-22000 is into 23000-25500. Need bit of caution at 24250-25250, supply from profit-booking urge, but not seen as reversal of positive undertone.

We had ventured into banking sector “buy strategy” for Big5 (1 PSU + 4 private banks) and bullish consolidation on others. Most got triggered: HDFC at 1025 to 1237 and KMB at 1230-1341 (of high value stocks); SBI at 176-198 and ICICI at 333-403 (systemic important on asset side) while missing on Axis Bank at 400-469, awaiting deeper correction into 275-300. IndusInd Bank did nice back & forth at set swing trade range at 450/485-665/700 (712-485-638). What Next? Undertone gets better after policy measures and good to be on upside chase with affordable trail stop. Where’s the t/p target? Need to watch upside break momentum on Bank Nifty at 23000/24250-25500.

India-US yield spread squeeze: spike in US yields from fiscal steroids and easing India yields from liquidity stimulus

US 10Y Treasury yield spike from 0.65% to 0.775-0.85% was the script, gradually moving up from 0.50-0.575% to 0.575-0.65% and now at 0.775-0.85%. This bearish momentum is largely to do with 2020 value appreciation by ~1.5% (2% to below 0.5%) and low probability of shift of FED Fund rate from zero to negative, hence the shift from Treasuries to equities. What Next? Given the FED guidance of zero interest rate regime till 2022, don’t see risk beyond 0.85-1% where investors appetite could emerge balancing the portfolio between equity & Treasury. So, let’s shift big picture focus from 0.50-0.85% to 0.65-1% with near term consolation at 0.675-0.85%.

India 10Y bond 5.77% 2030 push back from 6.075% to 5.925% is thanks to RBI Governor’s extraordinary measures, which can’t be seen as either innovative or out of the box given that the intent is to reduce the borrowing cost of the largest borrower in the system, which has doubled in FY21. It’s gone into vicious cycle mode (call it, round-tripping or trap) – deposits (marginal cost ~6%) invested in SLR bonds & given to RBI on OMOs (yield & cost neutral ~6%), cash from OMO sale reinvested either in R/R at 3.35% or subscribe to fresh issuance ~6% (holding excess SLR of 4% of NDTL, 22% against 18%, which is ₹6-7 Trillion) – from this cycle, it’s obvious that it makes sense to be aggressive investor on GOI bonds than lend to RBI at 3.35%. This cycle is fine as long as banks are happy with 10Y GOI yield ~6% when in credit risk aversion mode. Risks will emerge when credit demand picks up and policy rates start climbing. This phase may take 1-2 years, but need to keep this in mind when into long term investing mode on the comfort of HTM, which will not be available beyond March 2022, when the cycle could get cut, opening up the need to refinance 4% excess SLR at Repo rate for whatever purpose, alternate to high cost deposits or higher yield from good credit. For now, 10Y yield will not be allowed to go beyond 5.85/5.925-6/6.075%, so good to be in back & forth mode, notwithstanding India-US 10Y yield spread squeeze to 5.15% from 5.35-5.50%. Will FPIs stay invested at low yield spread of 5-5.15%? This is the risk factor which can’t be ignored for long term investment, hence caution!

USD index lose steam shifting into risk-neutral mode but not seen weak while ₹ exchange rate boxed between good supply and losing real interest rate advantage

USD Index DXY losing steam at higher end of 91.50/91.85-94.65/95 with push back hold at 92.50-93.25 is no surprise, and don’t see downside risk into 90-91.50 as yet with better prospects of upside break at 93.50-95 with pull bias into 96-97.50. For now, retain focus at 92.50/93.25-94.65/95. EUR/USD is boxed at 1.1650-1.1850, unable to sustain either way overshoot with no clarity beyond 1.15-1.20.

USD/INR back & forth between 72.65-72.80 and 74-74.15 in traction with 12M USD risk-neutral hedge comfort range 76-77 is in order, which is also liking to RBI to see price stability without RBI interference. Will RBI allow break down into 71.50-72.65 is the expectation now given that demand-supply dynamics is in favour of ₹ notwithstanding yield spread squeeze. For now, good to keep focus between 73.85-74.15 and 72.85-73.15 and watch for short-squeeze support at 72.50-72.85. Bottom-line, big picture is shifted from 73.50-77 to 71.50-75.

Gold regain confidence and so is Brent Crude

Gold resilient from below $1865 for bounce back into $1935 (1848.45-1930.83) is good despite being at lower half 1850/1865-2065/2080. It’s bias neutral on immediate term from USD stability and elevated Treasury yields. For now, good for consolidation at $1865-1965 given the dilution of safe haven support.

Brent Crude back & forth at 37.50-42.50 is the best to expect with hedge appetite at $35-37.50, lower end of big picture comfort range $35-50. Given the hope that worst is behind on demand (from growth contraction) and prepared next for supply side adjustment, there’s no need to look beyond $37.50/40-45/47.50.

All combined, last mile run into US Presidential election is turning good with no sign of sell-off ahead of the event Risk. It’s also emerging as tough & equal fight between Trump & Biden, while FED is prepared to do the balance between real economy & financial markets. It’s safe to be positive in the near term but prudent to stay with trail stop on the market! Be safe, have a great week ahead!

Moses Harding

Looking beyond policy rates & liquidity ratios

Mr. Das is a different Governor of Reserve Bank of India, having focus where none looks at. No surprise that policy rates kept unchanged and so is SLR & CRR while extending benefit of additional HTM dispensation (19.5% to 22%) from March 2021 to March 2022. Governor also took a leaf out of FED in proclaiming that accommodative policy will remain till FY22, and that growth is more relevant for the real economy than inflation. Liquidity window got opened wider for TLTRO and (out of the box) OMOs for SDL to ensure that yield spread between GOI & SDL and GOI & Corporate bond get squeezed, thus extending RBI support beyond Central Government to State Governments and corporate borrowers. Needless to say, all these are music to the ears of borrowers without much damage for depositors who take comfort from rate status-quo! So, it’s win-all policy and kudos to Mr. Das who is emerging as street-smart Governor with attention on innovation & impact rather than theory & text books!

There was little on credit comfort to push lending to needy sectors, but small steps made look big…

RBI game plan is to push Banks to lend (taking credit risk on themselves) pushing liquidity into their balance sheet – compulsive lending to avoid placing surplus monies at 3.35-4%. The excess liquidity will flow between subscription to GOI/SDL bonds and to private wholesale borrowers, both of which is music to the ears of RBI. Support to retail & home loans (higher limit and risk weight concession on lower LTV) are incidental to the objective of ensuring credit flow to retail borrowers.

What’s the impact from strategy of using Reverse Repo & liquidity tool in the absence of rate cut bandwidth?

Major impact is on long term benefit to the system, by efficient cost management of escalating government borrowing despite headwind dynamics, artificial administration of 10Y benchmark yield at sub 6% is beyond imagination. Markets responded positively to the pied piper giving more funds at post-policy cut-off yield at 5.94% (against previous devolved auction at 6.02%) – lower cost of debt for the Government without rate cut is win-win for the Government and depositors. Private borrowers stand to benefit from spread squeeze and more funds from TLTRO refinance window. Relief for Banks is from the comfort to keep acquiring Gilts to the brim of 22% of NDTL (HTM limit) with less worry on the mark-to-market from extended dispensation to March 2022. RBI has the comfort to dip into excess SLR of 4% (22% retention against 18% requirement) for release of liquidity into the system at Repo rate at 4%, may be effecting Repo rate cut when this situation arises!

Financial markets got into bullish undertone on run upto monetary policy – NIFTY shifting play from 10800-11800 to 11650/11800-12300/12450 and Bank NIFTY in outperformance mode with upside break at 20400-22000 into 22650/23000-24350/25350. 10Y benchmark yield push back into 5.85-5.95% without rate cut is achievement of sorts for the Governor. Despite investors jitters at sub 6% yield, RBI’s stubbornness on yield containment will improve investors appetite for medium term price stability at 5.85/5.925-6.025/6.10% removing the risk of yield spike into 6.10-6.35%. So, all is well in financial markets, and GOI should be happy with (exceeding expectation) performance of RBI Governor!

Will all these lead to turnaround in real economy in H2/FY21? These could at best be catalyst to the main course from the North block!

Moses Harding

Note: This article is follow-on to views penned on 4th and 12th September 2020 on evolvement of banking sector since 1994 and investors perspectives on way forward.

It’s sensible that NaMo 2.0 is focused on putting in place strong foundation ahead of building scale on the economic capacity with ambition of $5 Trillion GDP before 2024. Accordingly, the Government has pushed through reforms on social sector, agriculture, labour, while others on land, legal etc should be work in progress. To attract long term capital, there has been significant increase on FDI limits allowing majority foreign ownership in most sectors. It got easy when in command of majority in the lower house and support from like-minded regional parties in Rajya Sabha.

While lot’s being done on economic and monetary reforms, there’s lot to do in the banking sector that provides leverage to equity for capacity expansion. There’s strong bonding between GDP growth and performance of credit & non-SLR investments of the banking sector – direct and through shadow banks, the NBFC sector. The credit growth is estimated at 2-2.5X of GDP growth, which means that at 6% GDP growth, average credit growth rate of banking sector is at 12-15%.

Capital is scarce and big ticket sources are limited, hence the need to revisit promoter holding restrictions

Banks would need large dosage of capital for higher provisioning for Covid-19 impacted NPAs and to fuel growth engine in FY22. When time is of essence with less than six months to go for end of FY21, need to empower the banks with desired capital. While PSU banks are high dependent on the budgetary allocation, cash rich promoters of private banks don’t have the headroom to invest more than set upper limit of 15%, seeking for increase in “cap” to 25-40%? When ownership of Government in public sector banks is over 50% and licensing conditions for new generation private banks did stipulate the minimum holding of promoter at 40% to ensure that there’s more skin in the game over long term, RBI could consider limit enhancement from 15% to 26-40%.

Why the need for higher promoter holding relevant at this stage?

Government decision to sell majority stake of 7 (out of 12) PSU banks to private promoters would need offer of higher capital limit to get higher premium and entry of deep pocket entities. On the other side, having lost over 75% value from the peak and low investors appetite, it’s appropriate to give promoters the opportunity to bring in fresh capital beyond 15% to 26-40%, which will give confidence to regulators and other stakeholders that the promoters are indeed serious to ensure continuity & sustainability and keen to participate in lending for capacity expansion.

What’s relevant is establishing compliance & governance standards and not restrictions on capital structure

It’s good that the system has got the wake up call from bank failures from below par risk & compliance monitoring processes and inefficient governance standards. RBI is in the process of tightening regulatory supervision and Chinese-wall protection between promoters and management, avoiding conflict of interest and upgrade of board level supervision over risk & compliance keeping control functions outside the direct responsibility of the Chief Executive. It’s obvious that ensuring fool-proof compliance & governance standards mitigate risks from higher promoter holding while ensuring that interest of minority shareholders stay protected.

Cap of 40% holding by single/group ownership across public & private banks is good balance between governance & performance

Performance woes around public sector banks is largely attributed to dominant ownership by government while mishap in private banks is from failure of compliance & governance when the largest shareholder holding the reins of the management. When both the models have failed, it’s appropriate to think different approach with combination of single/group ownership cap to 40% and disconnecting the conflict of interest play between largest shareholder and the top management, avoiding double-hat with empowerment to the Board having good mix of Independent executive and non-executive directors. This model will lead to better monitoring jointly by hands-off promoters and eyes-in regulators.

It’s win–win advantage both for the system and stakeholders

It’s two-way advantage for the system as whole – flow of additional capital from promoters will increase the appetite of other institutional & retail investors to help banks recover the eroded value, thereby improving depressed sentiment of the banking sector. On the other hand, combination of higher CAR, leveraging higher share premium (for better EPS) will increase credit risk appetite of banks, which is need of the hour to pump debt capital into the system for capacity & credit expansion in FY22 & beyond. Combination of reinstatement of credit appetite and establishing fair value of banking sector is “two for one” reward for the system by providing the opportunity for those promoters that wish to put more monies at stake, seeking to enhance paid-up capital exposure from 15% to 26-40%.

Thinking aloud for the good of Indian economy & banking sector that needs to co-exist to establish economic prosperity and social wellness, and to provide catalyst push towards the ambition of becoming top-three economy of the world!

Moses Harding