Digged for Gold but got Copper

We came to know that Modi can take bold and tough decisions. But political mastery does not necessarily equate with mastery over economics. So the benefits of demonetization were overestimated and the inconveniences were underestimated by his close aides. And they had to learn hard way that poor execution can spoil a good strategy. Newly printed Rs.2,000 notes became an exchange for black money and created a large scale corruption. It proved that the majority of Indians are not ready to pay taxes they owe to the system.

Let us look at the negative effects first. Take a glance at credit growth rates, it shows that it has gone to 50 years low. Bad times for banks. Vehicle sales have plummeted. Construction industry is seeing a set back. What India badly needs is job creation but the jobs are being lost as the mass employing sector like construction is seeing a set-back. You think it is a temporary phenomenon, well, it is difficult to estimate when the turnaround will come. Forget growth, going back to past levels of valuation will take couple of years for the real estate industry, so there is not much motivation for investors.

There are many positives too. Interest rates are down, inflation is under check. Money in banking system has gone up. Cash to GDP ratio is reduced. Tax collections will see an upside. Indians learnt to use Paytm. Debit cards are not limited to withdraw cash at ATM’s and consumers as well as retailers are demanding for use of POS machines. All these will help offset the negative impacts over few years period. Unless monetary system is tampered again, India would absorb this shock and post higher growth rates.

Collectively, over a period of years, benefits may over weigh the injuries done by the demonetization. But the expectations were set very high that India would be clean in 50 days, which was quite unrealistic.They digged for Gold but what they found was Copper. It too has some value.

Rich will lose wealth and Poor will lose jobs

Debates on the effects of demonetization dominate every kind of media. Economists are rolling out all kinds of numbers from -0.25% to -3.5% of GDP growth slow down. While no one questions the intentions of this master stroke but the effectiveness of its implementation is where the opinions are divided. Look at following points and then you can form your opinions.

Time to Digtial Economy: This may look good as a slogan but do you know how much is the penetration of Internet and Smart Phones in our economy to go cashless? How will those living below the poverty line buy a smart phone and get a data pack to use mobile phone as their wallet? We do not have consistent power supply in many villages and when it rains, the mobile towers do not function for days. When villagers are struggling to get clean drinking water and primary health facilities, going for a cashless system will force them to migrate to towns but the cost of living in towns and the availability of jobs would put them into helpless situations for a long time to come. Our former PM Man Mohan Singh reminded us ‘In the long term, we all will be dead’. Yes, both the poor and rich, all of us die in the long term. But this move will likely make the poor move closer to their death prematurely. Short term impact can really be devastating. If the situation is not handled well, the same people who hail Modi now will begin to criticize him.

Self-Defeating mechanism kicks in: When Real Estate transactions reduce, construction activity reduces which employs unskilled labor in big numbers. And the consumption of Cement and Steel would come down. That would mean the mining activity will also see a slowdown. What will happen to the new investments in these sectors? How about the new jobs which were supposed to be created in these sectors? Automobile industry is cutting down their production levels. If the situation continues for some more time, how much will be the job loss resulting from it? When GDP growth begins to slow and deflation begins to hurt, rich will lose their wealth and poor will lose their jobs.

Pressure on banking system increases: We thought liquidity will drive down the interest rates but RBI has a different plan. It sucked out the liquidity, may be for a good reason. But this will push out the timing to reduce lending rates for banks. When the revenues are going down, profits will slide at a higher pace and this will put a dent on many companies ability to service their loans. Bad loans will raise again. Most of the existing bad loans are in Infrastructure space and that sector will see a significant headwind (as demand for cement, steel drops), so the pressure on banking system will intensify.

If relief measures (such as reducing taxes) are brought in, it may compensate for the damage partially but how soon they will roll it out and what would be the magnitude of it is not known yet. But the long queues at Banks show the struggle for a common man to get the cash to spend on the necessities. The behavior of Indian is going to change for sure, but will it be for good? It depends on further steps the Govt. will take. Acid test has begun for them. If they cannot manage it, they will learn a big lesson themselves despite good intentions.

The new divide: Bankable vs Non-Bankable

Demonetization is going to reduce the cash-supply in the system and force most of India’s population to use the banking system. This would impact the sectors where cash was used most – Real Estate. But real estate is a broad asset class of Agricultural, Industrial, Commercial and Residential. Valuation is different for these segments and all of them do not use the same cash level when they change hands. Take a look at this map. Agriculture is the segment where cash was used most in comparison to others. So when cash crunch begins to hurt, it is likely to hurt the segment which was heavily dependent on cash.

Housing prices will see lower impact as cash component is less and it is mostly bankable (can get loans). As the interest rates begin to drop, affordability starts cutting through lower income levels which has higher population. Any price erosion along with interest drop will see demand increasing at a faster pace so prices would stop from falling further and begin to reverse in a few months period.

After a few years from now, you will see that real estate assets having changed hands into the people who were bankable, who could raise loans. If you had paid your taxes promptly, there will be lots of opportunities knocking on your door to own some real estate in the near future. And don’t hesitate as India’s growth story remains firm.

Fundamental valuation of a stock

The following diagram summarizes the components of valuating a stock fundamentally. While most of us just concentrate on the Income statement, there is a need to go one level down and understand what influences those sub-components and their trajectory.

The difficult part is in guaging the P/E multiple. Whatever numbers we come up with for earnings growth rate are just estimates as we are trying to predict the future. We need to understand the company, its products, competitors, new developments in the sector etc. to get a reasonable estimate.

If we stick to the companies whose business we understand better, this valuation exercise might become a possible task and help us know if the stock is reasonably valued or is it under priced or otherwise. That will help us identify buying and selling ranges. These estimate ranges can be honed with experience. Rather than timing the market, if we focus on price levels, we might get lucky not just once but again and again as our portfolio performs better than market average.

It was the spring of hope, it was the winter of despair

“It was the best of times, it was the worst of times” so begins the legendary novel "A Tale of Two Cities". India too is at the same point.

We have Banks flushed with liquidity but the queues are long at ATM’s to withdraw a tiny amount of that cash ocean.

Experts are saying real estate prices will come down but if it that happens, construction sector will take a hit and many daily wage labors go jobless. They do not have skills to do other jobs. While many dream of buying a new home as they become affordable, those who build it are in despair.

Interest rates will be lower and you say happier times? But wait, GDP growth will come down too and that is not good news. "This is war on corruption" says those in power. But the opposition parties are asking "What prevents the corrupt asking for Rs.100 bills or Gold instead?" Is this time to smile or sigh?

Let us punish the black money hoarders, says the PM. But the poor are helping to convert the black money into white for a commission. Who is really corrupt? India is a land of contradictions. Always, in the past, now and in the future too. Is that our pride or enemy?

The more we clean more the debris piles up. The root of this evil is in higher population competing for limited resources. We, Indians are competing with ourselves rather than cooperating. Else, the corrupt are competing with whom else? Roots of Economics lie in Sociology. If we don’t fix the population growth or increase the resource availability (most of it is not in our hands), competition will only intensify. The tendency to hoard does not whither away. But none of our leaders (and media too) are talking about this. They are rather interested in dividing us by religion, income levels, black or white money holders. 

It is the season of Light, it is the season of Darkness. Hats off to Charles Dickens!