Managers like all of us are also suckers for easy answers. “Management as a discipline is in very early stages of development. The equivalent would be the subject of chemistry as it was in the fifteenth-sixteenth century when it was alchemy. For centuries people were looking for the philosopher’s stone which was some kind of catalyst which could turn base metal into gold. Management is a bit like that. So many managers are suckers for the guru who can provide the simple answer,” says Robert Grant. He is a professor of strategic management and holder of the ENI Chair of Strategic Management in the Energy Sector at Bocconi University in Milan, Italy. He is currently in India teaching a course on strategy to the first batch of students at the Mumbai International School of Business, an initiative of the SDA Bocconi School of Management in India. In this interview he speaks to Vivek Kaul.
You have talked about the fact that the knowledge and insight needed to make sound strategic decisions and guide the development of their organisations is best served by strategy teaching that is rooted in theory. What do you mean by that?
Some people would reject the whole notion of business education. Some would say that the best way to become a successful manager is to learn on the job i.e. there is no substitute for experience. Part of the whole notion of having a business school is to say that actually there are principles, and there are things that can be learnt from an analytical approach.
Can you explain this through an example?
You have individuals who appear to be successful managers and the question is what can we learn from them. Can we in anyway generalize about this? So you look at Apple and you say is Apple all about Steve Jobs? Then what was his leadership style? Here is a quirky individualistic, unconventional and a very autocratic management style. And you ask why has this worked? You look at a different company like IBM and its former CEO Sam Palmisano, who had a very different leadership style. You start looking at all these examples and say can we see patterns. Can we see something that we can generalize? Soresearch tries to generalise for this diversity of experience and then the teaching says that here are some principles that we can start applying.
You talked about Steve Jobs and Sam Palmisano two people with very different leadership styles. Which style works more often than not?
Palmisano fits in with a more observable trend you are seeing in large companies where leaders are becoming less the people who make the key decisions. The problem is that most organisations are so complex that the CEO knows maybe 2% of what is going on in that organisation. Also these days businesses have to respond so quickly that they can’t wait for the stuff to get to the CEO level before decisions can be made. So you have to have highly decentralized decision making. So what then is the role of the CEO? Increasingly the role of the CEO is to manage culture and manage the development of people within the organisation, rather than to take the role of the decision maker.
So where does that leave the likes of Jobs?
In many ways Jobs may well have been the one of the last of the old school. This was somebody who was very very hands on. In the early days he was the designer. At one level he was the Chairman of Apple Computers but he was also the project leader on the projects. He was very deeply involved in tiny details which he was incredibly emotionally attached to. So I think in terms of models of leadership probably companies are making some serious mistakes if they say the Jobs way is the way to go.
At some level he was also the biggest marketer of his company…
Yup. He was a great marketing guy because he was the founder of this incredibly successful company that was a major part of a social revolution that took computing, something that had been dominated by governments and large corporations, and taken it down to young people. He empowered young people.
So how do you see Apple performing now that he is not there to lead them?
The case with Apple is like all companies that have visionary powerful founders who go on to be their leaders. The key is can that intuition and vision of the founder, become embodied in the capabilities of the firm. The fact is that Jobs had from several years before his death increasingly distancing himself as the chief decision maker of the firm. This must mean that in terms of the culture of the company, the systems by which the products are designed, how they understand the market, technology, their users, and many of the intuitive level skills that Jobs had, have actually become embodied in the capabilities of the organisation. It’s the same with every entrepreneurial company. Can the company make the transition from a company which is entrepreneur led, family led, into an organisation which is professionally managed but has managed to embody those skills.
Does that happen?
It does happen. You look at Walt Disney. The values and the quest for quality entertainment orientated towards children and families is something that has become embodied in the set of capabilities at Disney. Wal-Mart has a culture where cost efficiency is almost like a religion. Avoiding all waste and looking for new solutions to keep costs down, was something that was a part of the protestant upbringing of Sam Walton. But it has been transferred into the company. So I think it does happen. And it has to happen if the company is going to make that transition.
In one of your research papers you write “I frequently observe a propensity to fall back on ideas and beliefs that amount to little more than folk wisdom.” Could you talk about that in a little detail?
Management as a discipline is in very early stages of development. The equivalent would be the subject of chemistry as it was in the fifteenth-sixteenth century when it was alchemy. For centuries people were looking for the philosopher’s stone which was some kind of catalyst which could turn base metal into gold. Management is a bit like that. So many managers are suckers for the guru who can provide the simple answer. Hence, all the time you have people coming up with the philosopher’s stone. These fads in management come and go. Go back to the late 1970s and the early 1980s market share was the in thing. If you need to get anywhere in business you need to have market share was the in thing. The way to get market share is penetration pricing. This is what the Japanese companies were doing. So that was the sort of thinking that dominated that era. It made sense but not in others. Since then we have had wave after wave of notions, typically given tremendous appeal by the fact that people espoused them are usually fantastic performers. People like Tom Peters for example.
I was about to take his name…
HaHa. To give them their credit most of them have a key value but it is all within a context. One of the ones that was most influential was CK Prahalad and his core competence of the corporation. For many business leaders this was a kind of a revelation that rather than going out there thinking about what does the customer want, it made more sense to start looking inside, what the hell do you well as a company? The article was written 22 years ago and now you look back and say, core competence, that is just one single thing. Now when you look at companies you say there is a whole network of things and the key is the way in which they all fit together. The tremendous danger is this belief that there can be a single idea that provides a universal solution.
How does folk wisdom prevalent in organisations at various points of time influences decisions made by senior executives in companies?
If you look at the lead up to the financial services crisis a phenomenon that you saw particularly among the retail banks was internationalizing. So nearly all the US banks, and major European banks said, we have to have a position in China. They bought minority stakes typically in Chinese banks. Look at Royal Bank of Scotland, which was a Scottish bank, and present only in Scotland. Then it acquired NatWest in Britain. Then they started acquiring banks elsewhere in Europe, in United States and Asia as well. Bank of Santander did the same thing. HSBC internationalized as well. Other banks like the UniCredit Bank started to say we need to get into the game. I remember having this executive seminar with one of the Italian banks and I asked them what are you doing right now? And I was told we are internationalizing. And when I asked them why? Because we are living in a global world, was the answer that came along. So what? This sort of notion of globalisation just takes hold of people and it almost becomes an excuse for not really thinking about what really makes sense.
So globalisation is the current fad…
It is one of the current fads. The question that needs to be asked is globalisation creating any value for many businesses? In the case of retail banking you acquire banks in different countries. Then you ask are there any benefits of having them under common ownership? For starters you have to put them under the same brand. But then the regulations in different countries are different. Hence banks in different countries have to be separately funded. They have to meet the reserve requirements specific to that country. The markets are very often different and so you can’t launch the same products. So you say, well hang on, does this make sense? The same is true about telecom. Vodafone is the most international company and yet in every country it has to acquire licenses, has to establish structure etc. So the question is where are the economies of scale? So they say, maybe the economies are in sourcing. And then you start sourcing phones on a global scale. But in Japan they want Japanese phones simply because those phones had higher standards than what consumers in the UK were happy with. So you start saying where is the value being added here?
Vodafone hasn’t been doing terribly well in India…
Another of the link to this globalisation is to say where do we need to be internationally? Emerging markets. Why do you need to be in emerging markets? Because that’s where the growth is. But growth doesn’t necessarily mean profitability. All those banks that went into China most of them have sold of their holdings now. The car companies are still rushing into China building plants. In China they growth of capacity in automobiles is faster than the growth of demand. So you have the same excess capacity that you have in Europe and North America and so most of these companies are not making money in China. When it comes to telecom the emerging markets are pretty much close to saturation. India has a brutally competitive market in telecom. This is not a market where France Telecom or AT&T can say hey if we move in we are going to make a lot of money. To a lot of extent there is this sort of naïve thinking that just because you are in a growth market you are going to make money.
What has been the impact of increased volatility and unpredictability of the business environment in the last few years upon the strategic planning processes of companies?
What this means that you can’t forecast. So you have to have a planning system which is based upon the notion that actually you don’t really know, what is going to happen next week, let alone next year. And that is a major challenge. Though you don’t know what the environment is going to be you still need to make investments. The oil companies are making investments in oil fields and majorly into gas fields. These fields aren’t going to come on stream for another six, seven, eight years and then they are going to last for another 20-30 years. But nobody knows what the price of gas is going to be in six month’s time, let alone in ten years.
So the companies need to function more and more like venture capitalists?
I think you are onto something here. What companies increasingly need to do is not so much as manage a portfolio of major businesses necessarily, but at least have a portfolio of options. So they are looking at the future and saying we don’t know what is going to happen. But maybe we can engage in some in alternative scenarios now and make relatively small investments, so that if the market develops in this way, we can expand on that base and really exploit that opportunity.
Can you give an example to explain that?
Some of the technology companies are quite good at this. If you look at Google and ask what is it doing, you realise that wow it’s all over the place. And yet it is doing things that make sense in an environment of uncertain change. It started Android its mobile device operating system with the realisation that even though it was dominating search within PCs, laptops and so on, the internet access was increasingly going to move to mobile devices in the days to come. So that was a threat to Google because the question was that would these mobile devices be compatible with the Google search engine? So they decided that maybe if we have our own operating system then we can ensure all our applications are going to run on it. Then of course RIM and then Apple became the dominant players in the mobile business. Apple likes its close garden. It likes to control its own applications through its own app store and so on.
So what happened?
Google exercised the Android option, which was basically an embryonic protocol operating system. It then said we are going to launch this, we are going to invest in this, we are going to talk to major handset makers and provide them with the necessary tools to support it and so on. This despite the fact that Android was free and Google wasn’t making any money out of it. But it became a way of ensuring that their Google search engine and other Google products could make their movement into the mobile sector. Then they start saying what are the threats that we face in terms of our desktop applications? We are dependant upon Microsoft because our search engine runs on the Microsoft browser, internet explorer. It also runs on the Microsoft operating system. So again they said lets introduce Chrome. It’s an option. It’s not a massive investment. But it’s their own browser. And then they came up with the Chrome operating system as well. And it becomes an alternative. In fact they haven’t had to make a massive investment in rollout because Firefox’s Mozilla has eroded Microsoft’s clout and Microsoft is no longer dominant in the browser business. That’s one way of interpreting what companies are doing.
This approach you talk about might be possible in technology because expenses are not huge. But what about other businesses?
You look at the oil business. Nobody knows what the price of oil is going to be. Nobody knows if the House of Sa’ud is going to fall. Maybe that could be next domino. Nobody knows if the Israelis are going to bomb the hell out of Iran. So there is all that uncertainty in this business. So companies are hedging their bets. They are making investments in shale gas. They are taking minority stakes. The Chinese are taking stakes in the oil sands of Canada. But most of those are just minority stakes. But it’s enough for them to say that if it looks like that we are going to lose a lot of our upstream oil reserves, if the price of oil is going to rocket, then we are in a position now to understand enough about this business either to expand it internally or acquire a majority stake. Just looking at the options approach it means that you are building flexibility. It is building your ability to adapt.
(The interview originally appeared in the Daily News and Analysis on August 20,2012. http://www.dnaindia.com/money/interview_many-managers-are-suckers-for-the-guru-who-can-provide-the-philosophers-stone_1730122))
(Interviewer Kaul is a writer and can be reached at [email protected])
Oil
A policy rate Catch 22
Vivek Kaul
“That’s some catch, that Catch-22,” says Yossarian, the lead character in Joseph Heller’s all time classic Catch 22. Duvvuri Subbarao, the governor of the Reserve Bank of India (RBI) is facing a Catch 22 situation currently and some catch it is.
He needs to decide whether to encourage economic growth or to control inflation. Theoretically Subbarao can encourage economic growth by cutting the interest rates. But that is likely to fuel inflation as people and companies will borrow and spend more, leading to a rise in prices.
He can control inflation by keeping the interest rates high. But that kills economic growth as businesses don’t borrow money to expand and people go slow on taking loans for purchasing cars, motorcycles, homes and consumer durables. This hurts businesses and slows down economic growth.
The RBI seems to be trying to control inflation by keeping the interest rates high rather than try and encourage economic growth by cutting the interest rate. In the first quarter review of monetary policy 2012-2013 which was released on July 31, 2012, the RBI decided to keep the repo rate at 8%. Repo rate is the interest rate at which the RBI lends to banks.
By keeping the repo rate high the RBI hopes to control inflation. “The primary focus of monetary policy remains inflation control,” the RBI said in a statement. But economic theory and practice don’t always go together.
The inflation in India is primarily on account of rising oil prices and food prices. Oil is a commodity that is bought and sold internationally and the RBI cannot control its price. The price of oil has been falling since the beginning of this year but it has started to inch its way back up and as I write this, brent crude oil is quoting at $105per barrel. While the government has shielded the people from a rise in oil price by not raising the price of diesel, LPG and kerosene, petrol prices have been raised.
As far as food is concerned there seems to be a structural shift happening. “The stickiness in inflation…was largely on account of high primary food inflation…due to an unusual spike in vegetable prices and sustained high inflation in protein items,” the RBI said.
Protein items primarily include various kinds of pulses, milk and other dairy items. The various social schemes being run by the current United Progressive Alliance (UPA) government have put more money into the hands of rural India. One thing that seems to have happened because of this is that people are eating better than before.
Economic theory suggests that once income levels rise above $1000 per annum, a major portion of the increased income is spent on more food and better quality food. Also people shift from cereal based diets to protein based diets. In large parts of the world this means an increase in the consumption of meat. But in India it means more consumption of milk and pulses. Again this is something that the RBI has no control over. As long as the UPA keeps running its social schemes this phenomenon of increased food prices is likely to continue.
What does not help in the near term is a deficient monsoon. Rainfall upto July 25,2012 has been 22% below its long period average. This means food prices will continue to rise.
What this clearly tells us is that RBI is not in a position to control inflation as it stands today. So should it be cutting the repo rate and in the process encouraging economic growth?
When RBI cuts the repo rate it is essentially giving a signal to banks that it expects the interest rates to go down in the days to come. But it is upto the banks to decide whether they take that signal seriously. When the RBI cut the repo rate by 50 basis points (one basis point is one hundredth of a percentage point) in April, the banks cut their interest rates by only 25 basis points on an average.
The reason was the increased borrowing by the government to finance its growing fiscal deficit. Fiscal deficit is the difference between what the government earns and what it spends. Between 2007 and 2012 the fiscal deficit of the government has gone up by more than 300%. During the same period its income has increased by just 36%.
The fiscal deficit has been growing on account of various subsidies like oil, food and fertizlier being offered by the government. “During April-May 2012, while food subsidies were lower, fertiliser subsidies were more than twice the previous year’s level,” the RBI statement pointed out. What also does not help is the fact that the Rs 43,580 crore oil subsidy budgeted for this year has already run out. The government compensates the oil marketing companies (OMCs) for selling kerosene, diesel and LPG at below cost. With oil prices over $100 again, the oil subsidies are likely to increase in the days to come.
This means increased borrowing by the government to compensate the OMCs for their losses. Increased borrowing by the government will mean that banks will have a lower pool of money to borrow from and hence they will have to continue to offer high interest rates on their deposits and charge high interest rates on their loans.
So what is the way out? “Clearly, if the target of restricting the expenditure on subsidies to under 2 per cent of GDP in 2012-13, as set out in the Union Budget, is to be achieved, immediate action on fuel and fertiliser subsidies will be required,” the RBI said.
But raising prices is easier said than done. Another theory being bandied around is that Duvvuri Subbarao is Chiddu’s baby (P Chidambaram, the Home Minister) and he will start cutting the repo rate as soon as Chidambaram is back at the Finance Ministry.
(The article originally appeared in the Asian Age/Deccan Chronicle on August 1,2012. http://www.asianage.com/columnists/policy-rate-catch-22-677)
The article was written before P Chidambaram was appointed as the Finance Minister
(Vivek Kaul is a Mumbai based writer and can be reached at [email protected])
An SSC pass understands that inflation today has nothing to do with RBI
Vivek Kaul
The attempts of the Reserve Bank of India (RBI) to control inflation have been a non-starter. “Growth, particularly in the last two or three years, has been worth its weight in gold. In a global economic boom, an economic growth of 8%, 7% or 9% doesn’t really matter. But when the world is slowing down, in fact growth in large parts of the world has turned negative, to kill that growth by raising the interest rate is inhuman. It is almost like a sin. And the RBI killed it under the very lofty ideal that we will tame inflation by killing growth,” said Shankar Sharma, vice-chairman & joint managing director, First Global, in an interview to DNA Money.
“If you have got a matriculation degree, you will understand that India’s inflation has got nothing to do with RBI’s policies. Your inflation is largely international commodity price driven. Your local interest rate policies have got nothing to do with that. We have seen that inflation has remained stubbornly high no matter what Mint Street has done. You should have understood this one commonsensical thing,” he added.
Given this, Sharma feels that there is no way out for the RBI but to cut the repo rate in the days to come. Repo rate is the rate at which RBI lends money to the banks. “I do not rule out a 150 basis points cut in the repo rate this year. Manmohan Singh might have just put in the ears of Subbarao that it’s about time that you woke up and smelt the coffee. You have no control over inflation. But you have control over growth, at least peripherally,” said Sharma.
Growth is the only antidote to inflation, feels Sharma. “If your nominal growth is 15%, you will get 10-20% salary and wage hikes. Then you have more purchasing power left in the hands of the consumer to deal with increased price of dal or milk or chicken. If the wage hikes don’t happen, you are leaving less purchasing power in the hands of people. And wage hikes won’t happen if you have killed economic growth,” explained Sharma.
And getting economic growth started again will be very difficult. As Sharma put it “The laws of physics say that you have to put in a lot of effort to get a stalled car going, yaar. But if it was going at a moderate pace, to accelerate is not a big issue. We have killed that whole momentum. And remember that 5-6%, economic growth, in my view, is a disastrous situation for a country like India. You can’t say we are still growing.”
By keeping interest rates high the RBI has managed to slowdown credit growth of banks and thus made borrowing easy for the government of India, which has been borrowing big time to finance its fiscal deficit. Fiscal deficit is the difference between what the government earns and it spends. “There are not many competing borrowers from the same pool of money that the government borrows from. So far, indications are that the government will be able to get what it wants without disturbing the overall borrowing environment substantially. In a strange sort of way the government’s ability to borrow has been enhanced by the RBI’s policy of killing growth. I always say that India has 33 crore Gods and Goddesses. They find a way to solve our problems,” said Sharma.
Sharma also sees the rupee appreciating against the dollar, a prediction he made at the beginning of the year and which hasn’t worked out till now. But his optimism still remains. “I still maintain that by the end of the year you are going to see a vastly stronger rupee. I believe it will be Rs 44-45 against the dollar. Or if you are going to say that is too optimistic may be Rs 47-48. But I don’t think it’s going to be Rs 60-65 or anything like that.”
A major reason for Sharma’s optimism is a fall in oil prices and Indians buying lesser gold.
“At the beginning of the year our view that oil prices will be sharply lower. That time we were trading at around $105-110 per barrel. Our view was that this year we would see oil prices of around $65-75. So we almost got to $77 per barrel (Nymex). We have bounced back a bit. But that’s okay. Our view still remains that you will see oil prices being vastly lower this year and next year as well, which is again great news for India,” said Sharma. Also with gold prices touching all time highs in rupee terms gold imports have taken a beating.
“You should be seeing a much stronger rupee by the end of the year. Imagine what that does to the equity market. That has a big, big effect because then foreign investors sitting in the sidelines start to play catch-up,” concluded Sharma.
(The article originally appeared in the Daily News and Analysis on July 31,2012. http://www.dnaindia.com/money/report_an-ssc-pass-understands-that-inflation-today-has-nothing-to-do-with-rbi_1721962)
(Vivek Kaul is a writer and can be reached at [email protected])
'You can shut the equity market, India would still be doing fine'
Have you ever heard someone call equity a short term investment class? Chances are no. “I have always had this notion for many years that people buy equities because they like to be excited. It’s not just about the returns they make out of it… You can build a case for equities on a three year basis. But long term investing is all rubbish, I have never believed in it,” says Shankar Sharma, vice-chairman & joint managing director, First Global. In this freewheeling
interview he speaks to Vivek Kaul.
Six months into the year, what’s your take on equities now?
Globally markets are looking terrible, particularly emerging markets. Just about every major country you can think of is stalling in terms of growth. And I don’t see how that can ever come back to the go-go years of 2003-2007. The excesses are going to take an incredible amount of time to work their way out. They are not even prepared to work off the excesses, so that’s the other problem.
Why do you say that?
If you look at the pattern in the European elections the incumbents lost because they were trying to push for austerity. And the more leftist parties have come to power. Now leftists are usually the more austere end of the political spectrum. But they have been voted to power, paradoxically, because they are promising less austerity. All the major nations in the world are democracies barring China. And that’s the whole problem. You can’t push through austerity that easily in a democracy, but that is what is really needed. Even China cannot push through austerity because of a powder-keg social situation. And I find it very strange when people criticise India for subsidies and all that. India is far less profligate than many nations including China.
Can you elaborate on that?
Every country has to subsidise, be it farm subsidies in the West or manufacturing subsidies in China, because ultimately whether you are a capitalist or a communist, people are people. They don’t necessarily change their views depending on which political ideology is at the centre. They ultimately want freebies and handouts. In a country like India, they don’t even want handouts they just want subsistence, given the level of poverty. The only thing that you can do with subsidies is to figure out how to control them. But a lot of it is really out of your control. If you have a global inflation in food prices or oil prices you are not increasing the quantum in volume terms of the subsidy. But because of price inflation, the number inflates. So why blame India? I find it absurd that the Financial Times or the Economist are perennially anti-India. They just isolate India and say that it has got wasteful expenditure programmes. A lot of countries hide things. India, unfortunately, is far more transparent in its reporting. It is easy to pick holes when you are transparent. China gives no transparency so people assume that whatever is inside the black box must be okay. That said, I firmly believe the UID program, when fully implemented, will make subsidies go lower by cutting out bogus recipients.
If increased austerity is not a solution, where does that leave us?
Increased austerity, while that is a solution, it is not achievable. If that is not possible what is the solution? You then have a continual stream of increasing debt in one form or the other, keep calling it a variety of names. But you just keep kicking the can down the road for somebody else to deal with it as long as the voter is happy. Given this, I don’t see how you can have any resurgence. Risk appetite is what drives equity markets. Otherwise you and I would be buying bonds all the time. In today’s environment and in the foreseeable future, we are overfed with risk. Where is the appetite to take more risk and go, buy equities?
So are you suggesting that people won’t be buying stocks?
Well you can get pretty good returns in fixed income. Instead of buying emerging-market stocks if you buy bonds of good companies, you can get 6-7% dollar yield, and if you leverage yourself two times or something, you are talking about annual returns of 14-15% dollar returns. You can’t beat that by buying equities, boss! Even if you did beat that by buying equities, let’s say you made 20%, it is not a predictable 20%, which has been my case for a long time against equities. Equities are a western fashion. I have always had this notion for many years that people buy equities because they like to be excited. It’s not just about the returns they make out of it: it is about the whole entertainment quotient attached to stock investing that drives investors. There is 24-hour television. Tickers. Cocktail discussions. Compared with that, bonds are so boring and uncool. Purely financially, shorn of all hype, equities have never been able to build a case for themselves on a ten-year return basis. You can build a case for equities on a three-year basis. But long-term investing is all rubbish, I have never believed in it.
So investing regularly in equities, doing SIPs, buying Ulips, doesn’t make sense?
I don’t buy the whole logic of long-term equity investing because equity investing comes with a huge volatility attached to it. People just say “equities have beaten bonds”. But even in India they have not. Also people never adjust for the volatility of equity returns. So if you make 15% in equity and let’s say, in a country like India, you make 10% in bonds – that’s about what you might have averaged over a 15-20 year period because in the 1990s we had far higher interest rates. Interest rates have now climbed back to that kind of level of 9-10%. Divide that by the standard deviation of the returns and you will never find a good case for equities over a long-term period. So equity is actually a short-term instrument. Anybody who tells you otherwise is really bluffing you. All the fancy graphs and charts are rubbish.
Are they?
Yes. They are all massaged with sort of selective use of data to present a certain picture because it’s a huge industry which feeds off it globally. So you have brokers like us. You have investment bankers. You have distributors. We all feed off this. Ultimately we are a burden on the investor, and a greater burden on society — which is also why I believe that the best days of financial services is behind us: the market simply won’t pay such high costs for such little value added. Whatever little return that the little guy gets is taken away by guys like us. How is the investor ever going to make money, adjusted for volatility, adjusted for the huge cost imposed on him to access the equity markets? It just doesn’t add up. The customer never owns a yacht. And separately, I firmly believe making money in the markets is largely a game of luck. Even the best investors, including Buffet, have a strike rate of no more than 50-60% right calls. Would you entrust your life to a surgeon with that sort of success rate?! You’d be nuts to do that. So why should we revere gurus who do just about as well as a coin-flipper. Which is why I am always mystified why so many fund managers are so arrogant. We mistake luck for competence all the time. Making money requires plain luck. But hanging onto that money is where you require skill. So the way I look at it is that I was lucky that I got 25 good years in this equity investing game thanks to Alan Greenspan who came in the eighties and pumped up the whole global appetite for risk. Those days are gone. I doubt if you are going to see a broad bull market emerging in equities for a while to come.
And this is true for both the developing and the developed world?
If anything it is truer for the developing world because as it is, emerging market investors are more risk-averse than the developed-world investors. We see too much of risk in our day to day lives and so we want security when it comes to our financial investing. Investing in equity is a mindset. That when I am secure, I have got good visibility of my future, be it employment or business or taxes, when all those things are set, then I say okay, now I can take some risk in life. But look across emerging markets, look at Brazil’s history, look at Russia’s history, look at India’s history, look at China’s history, do you think citizens of any of these countries can say I have had a great time for years now? That life has been nice and peaceful? I have a good house with a good job with two kids playing in the lawn with a picket fence? Sorry, boss, that has never happened.
And the developed world is different?
It’s exactly the opposite in the west. Rightly or wrongly, they have been given a lifestyle which was not sustainable, as we now know. But for the period it sustained, it kind of bred a certain amount of risk-taking because life was very secure. The economy was doing well. You had two cars in the garage. You had two cute little kids playing in the lawn. Good community life. Lots of eating places. You were bred to believe that life is going to be good so hence hey, take some risk with your capital.
The government also encouraged risk taking?
The government and Wall Street are in bed in the US. People were forced to invest in equities under the pretext that equities will beat bonds. They did for a while. Nevertheless, if you go back thirty years to 1982, when the last bull market in stocks started in the United States and look at returns since then, bonds have beaten equities. But who does all this math? And Americans are naturally more gullible to hype. But now western investors and individuals are now going to think like us. Last ten years have been bad for them and the next ten years look even worse. Their appetite for risk has further diminished because their picket fences, their houses all got mortgaged. Now they know that it was not an American dream, it was an American nightmare.
At the beginning of the year you said that the stock market in India will do really well…
At the beginning of the year our view was that this would be a breakaway year for India versus the emerging market pack. In terms of nominal returns India is up 13%. Brazil is down 3%. China is down, Russia is also down. The 13% return would not be that notable if everything was up 15% and we were up 25%. But right now, we are in a bear market and in that context, a 13-15% outperformance cannot be scoffed off at.
What about the rupee? Your thesis was that it will appreciate…
Let me explain why I made that argument. We were very bearish on China at the beginning of the year. Obviously when you are bearish on China, you have to be bearish on commodities. When you are bearish on commodities then Russia and Brazil also suffer. In fact, it is my view that Russia, China, Brazil are secular shorts, and so are industrial commodities: we can put multi-year shorts on them. So that’s the easy part of the analysis. The other part is that those weaknesses help India because we are consumers of commodities at the margin. The only fly in the ointment was the rupee. I still maintain that by the end of the year you are going to see a vastly stronger rupee. I believe it will be Rs 44-45 against the dollar. Or if you are going to say that is too optimistic may be Rs 47-48. But I don’t think it’s going to be Rs 60-65 or anything like that. At the beginning of the year our view that oil prices will be sharply lower. That time we were trading at around $105-110 per barrel. Our view was that this year we would see oil prices of around $65-75. So we almost got to $77 per barrel (Nymex). We have bounced back a bit. But that’s okay. Our view still remains that you will see oil prices being vastly lower this year and next year as well, which is again great news for India. Gold imports, which form a large part of the current account deficit, shorn of it, we have a current account deficit of around 1.5% of the GDP or maybe 1%. We imported around $60 billion or so of gold last year. Our call was that people would not be buying as much gold this year as they did last year. And so far the data suggests that gold imports are down sharply.
So there is less appetite for gold?
Yes. In rupee terms the price of gold has actually gone up. So there is far less appetite for gold. I was in Dubai recently which is a big gold trading centre. It has been an absolute massacre there with Indians not buying as much gold as they did last year. Oil and gold being major constituents of the current account deficit our argument was that both of those numbers are going to be better this year than last year. Based on these facts, a 55/$ exchange rate against the dollar is not sustainable in my view. The underlyings have changed. I don’t think the current situation can sustain and the rupee has to strengthen. And strengthen to Rs 44, 45 or 46, somewhere in that continuum, during the course of the year. Imagine what that does to the equity market. That has a big, big effect because then foreign investors sitting in the sidelines start to play catch-up.
Does the fiscal deficit worry you?
It is not the deficit that matters, but the resultant debt that is taken on to finance the deficit. India’s debt to GDP ratio has been superb over the last 8-9 years. Yes, we have got persistent deficits throughout but our debt to GDP ratio was 90-95% in 2003, that’s down to maybe 65% now. So explain that to me? The point is that as long as the deficit fuels growth, that growth fuels tax collections, those tax collections go and give you better revenues, the virtuous cycle of a deficit should result in a better debt to GDP situation. India’s deficit has actually contributed to the lowering of the debt burden on the national exchequer. The interest payments were 50% of the budgetary receipts 7-8 years back. Now they are about 32-33%. So you have basically freed up 17% of the inflows and this the government has diverted to social schemes. And these social schemes end up producing good revenues for a lot of Indian companies. The growth for fast-moving consumer goods, mobile telephony, two wheelers and even Maruti cars, largely comes from semi-urban, semi-rural or even rural India.
What are you trying to suggest?
This growth is coming from social schemes being run by the government. These schemes have pushed more money in the hands of people. They go out and consume more. Because remember that they are marginal people and there is a lot of pent-up desire to consume. So when they get money they don’t actually save it, they consume it. That has driven the bottomlines of all FMCG and rural serving companies. And, interestingly, rural serving companies are high-tax paying companies. Bajaj Auto, Hindustan Lever or ITC pay near-full taxes, if not full taxes. This is a great thing because you are pushing money into the hands of the rural consumer. The rural consumer consumes from companies which are full taxpayers. That boosts government revenues. So if you boost consumption it boosts your overall fiscal situation. It’s a wonderful virtuous cycle — I cannot criticise it at all. What has happened in past two years is not representative. It is only because of the higher oil prices and food prices that the fiscal deficit has gone up.
What is your take on interest rates?
I have been very critical of the Reserve Bank of India’s (RBI) policies in the last two years or so. We were running at 8-8.5% economic growth last year. Growth, particularly in the last two or three years, has been worth its weight in gold. In a global economic boom, an economic growth of 8%, 7% or 9% doesn’t really matter. But when the world is slowing down, in fact growth in large parts of the world has turned negative, to kill that growth by raising the interest rate is inhuman. It is almost like a sin. And they killed it under the very lofty ideal that we will tame inflation by killing growth. But if you have got a matriculation degree, you will understand that India’s inflation has got nothing to do with RBI’s policies. Your inflation is largely international commodity price driven. Your local interest rate policies have got nothing to do with that. We have seen that inflation has remained stubbornly high no matter what Mint Street has done. You should have understood this one commonsensical thing. In fact, growth is the only antidote to inflation in a country like India. When you have economic growth, average salaries and wages, kind of lead that. So if your nominal growth is 15%, you will 10-20% salary and wage hikes – we have seen that in the growth years in India. Then you have more purchasing power left in the hands of the consumer to deal with increased price of dal or milk or chicken or whatever it is. If the wage hikes don’t happen, you are leaving less purchasing power in the hands of people. And wage hikes won’t happen if you have killed economic growth. I would look at it in a completely different way. The RBI has to be pro-growth because they no control of inflation.
So they basically need to cut the repo rate?
They have to.
But will that have an impact? Because ultimately the government is the major borrower in the market right now…
Look, again, this is something that I said last year — that it is very easy to kill growth but to bring it back again is a superhuman task because life is only about momentum. The laws of physics say that you have to put in a lot of effort to get a stalled car going, yaar. But if it was going at a moderate pace, to accelerate is not a big issue. We have killed that whole momentum. And remember that 5-6%, economic growth, in my view, is a disastrous situation for a country like India. You can’t say we are still growing. 8% was good. 9% was great. But 4-5% is almost stalling speed for an economy of our kind. So in my view the car is at a standstill. Now you need to be very aggressive on a variety of fronts be it government policy or monetary policy.
What about the government borrowings?
The government’s job has been made easy by the RBI by slowing down credit growth. There are not many competing borrowers from the same pool of money that the government borrows from. So far, indications are that the government will be able to get what it wants without disturbing the overall borrowing environment substantially. Overall bond yields in India will go sharply lower given the slowdown in credit growth. So in a strange sort of way the government’s ability to borrow has been enhanced by the RBI’s policy of killing growth. I always say that India is a land of Gods. We have 33 crore Gods and Goddesses. They find a way to solve our problems.
So how long is it likely to take for the interest rates to come down?
The interest rate cycle has peaked out. I don’t think we are going to see any hikes for a long time to come. And we should see aggressive cuts in the repo rate this year. Another 150 basis points, I would not rule out. Manmohan Singh might have just put in the ears of Subbarao that it’s about time that you woke up and smelt the coffee. You have no control over inflation. But you have control over growth, at least peripherally. At least do what you can do, instead of chasing after what you can’t do.
Manmohan Singh in his role as a finance minister is being advised by C Rangarajan, Montek Singh Ahulwalia and Kaushik Basu. How do you see that going?
I find that economists don’t do basic maths or basic financial analysis of macro data. Again, to give you the example of the fiscal deficit and I am no economist. All I kept hearing was fiscal deficit, fiscal deficit, fiscal deficit. I asked my economist: screw this number and show me how the debt situation in India has panned out. And when I saw that number, I said: what are people talking about? If your debt to GDP is down by a third, why are people focused on the intermediate number? But none of these economists I ever heard them say that India’s debt to GDP ratio is down. I wrote to all of them, please, for God’s sake, start talking about it. Then I heard Kaushik Basu talk about it. If a fool like me can figure this out, you are doing this macro stuff 24×7. You should have had this as a headline all the time. But did you ever hear of this? Hence I am not really impressed who come from abroad and try to advise us. But be that as it may it is better to have them than an IAS officer doing it. I will take this.
You talked about equity being a short-term investment class. So which stocks should an Indian investor be betting his money right now?
I am optimistic about India within the context of a very troubled global situation. And I do believe that it’s not just about equity markets but as a nation we are destined for greatness. You can shut down the equity markets and India would still be doing what it is supposed to do. But coming from you I find it a little strange…
I have always believed that equity markets are good for intermediaries like us. And I am not cribbing. It’s been good to me. But I have to be honest. I have made a lot of money in this business doesn’t mean all investors have made a lot of money. At least we can be honest about it. But that said, I am optimistic about Indian equities this year. We will do well in a very, very tough year. At the beginning of the year, I thought we will go to an all-time high. I still see the market going up 10-15% from the current levels.
So basically you see the Sensex at around 19,000?
At the beginning of the year, you would have taken it when the Sensex was at 15,000 levels. Again, we have to adjust our sights downwards. A drought angle has come up which I think is a very troublesome situation. And that’s very recent. In light of that I do think we will still do okay, it will definitely not be at the new high situation.
What stocks are you bullish on?
We had been bearish on infrastructure for a very long time, from the top of the market in 2007 till the bottom in December last year. We changed our view in December and January on stocks like L&T, Jaiprakash Industries and IVRCL. Even though the businesses are not, by and large, of good quality — I am not a big believer in buying quality businesses. I don’t believe that any business can remain a quality business for a very long period of time. Everything has a shelf life. Every business looks quality at a given point of time and then people come and arbitrage away the returns. So there are no permanent themes. And we continue to like these stocks. We have liked PSU banks a lot this year, because we see bond yields falling sharply this year.
Aren’t bad loans a huge concern with these banks?
There is a company in Delhi — I won’t name it. This company has been through 3-4 four corporate debt restructurings. It is going to return the loans in the next year or two. If this company can pay back, there is no problem of NPAs, boss. The loans are not bogus loans without any asset backing. There are a lot of assets. At the end of every large project there is something called real estate. All those projects were set up with Rs 5 lakh per acre kind of pricing for land. Prices are now Rs 50 lakh per acre or Rs 1 crore or Rs 1.5 crore per acre. If nothing else, dismantle the damn plant, you will get enough money from the real estate to repay the loans of the public sector banks. So I am not at all concerned on the debt part. If the promoter finds that is going to happen, he will find some money to pay the bank and keep the real estate.
On the same note, do you see Vijay Mallya surviving?
100% he will survive. And Kingfisher must survive, because you can’t only have crap airlines like Jet and British Airways. If God ever wanted to fly on earth, he would have flown Kingfisher.
So he will find the money?
Of course! At worst, if United Spirits gets sold, that’s a stock that can double or triple from here. I am very optimistic about United Spirits. Be it the business or just on the technical factor that if Mallya is unable to repay and his stake is put up for sale, you will find bidders from all over the world converging.
So you are talking about the stock and not Mallya?
Haan to Mallya will find a way to survive. Indian promoters are great survivors. We as a nation are great survivors.
How do you see gold?
I don’t have a strong view on gold. I don’t understand it well enough to make big call on gold, even though I am an Indian. One thing I do know is that our fascination with gold has very strong economic moorings. We should credit Indians for having figured out what is a multi century asset class. Indians have figured out that equities are a fashionable thing meant for the Nariman Points of the world, but for us what has worked for the last 2000 years is what is going to work for the next 2000 years.
What about the paper money system, how do you see that?
I don’t think anything very drastic where the paper money system goes out of the window and we find some other ways to do business with each. Or at least I don’t think it will happen in my life time. But it’s a nice cute notion to keep dreaming about.
At least all the gold bugs keep talking about the collapse of the paper money system…
I know. I don’t think it’s going to happen. But I don’t think that needs to happen for gold to remain fashionable. I don’t think the two things are necessarily correlated. I think just the notion of that happening is good enough to keep gold prices high.
(A slightly smaller version of the interview appeared in the Daily News and Analysis on July 31,2012. http://www.dnaindia.com/money/interview_you-can-shut-the-equity-market-india-would-still-be-doing-fine_1721939)
(Interviewer Kaul is a writer and can be reached at [email protected])
Post-WPI, Subbarao’s music may be more Baba Sehgal than Ilaiyaraaja
As I sit down to write this it is a rather cloudy, dull and insipid morning in Mumbai. An old Tamil number Vaa Vennila composed by the music maestro Ilaiyaraaja and sung by S P Balasubrahmanyam and S Janaki, is playing in the background. I happened to discover this song a few days back, quite by chance, and it has been playing nonstop on my laptop since then. It’s the most melodious composition that I have heard in a long-long time.
Dear Reader, before you start breaking your head over why am I talking about an old Ilaiyaraaja number, when the headline clearly tells you that I should be talking about other things, allow me to explain.
For a music director to be able to create melody a lot of things need to come together. First and foremost the tune has to be good. On top of that the musicians have to be able to flesh out the tune in a way that the music director had originally envisaged it. The lyrics need to make sense. The singers need to get the right emotion into the song and of course not be out of tune. The director of the movie needs to have the ability to recognize a good song when he hears one and not fiddle around with it. And so on.
The point I am trying to make is that “melody” cannot be created in isolation. A lot of things need to come together to create a melodious song and to have an individual born and brought in erstwhile Bihar of Kashmiri Pandit parents, who does not speak a word of Tamil (and not much Kashmiri either), humming it nearly 26 years after it was first released.
What is true about Ilaiyaraaja’s ability to create melody is also true about the ability of Duvvuri Subbarao, the governor of the Reserve Bank of India(RBI), to influence the Indian economy and take it in the direction where everyone wants him to.
The inflation number
The wholesale price index (WPI) inflation number for the month of June 2012 was released sometime back. The inflation has fallen to 7.25% against 7.55% in the month of May. The number has come in much lower than what the analysts and the economists were expecting it to be.
This is likely to lead to calls for the Reserve Bank of India (RBI) RBI to cut the repo rate.
The first quarter review of the monetary policy of the RBI is scheduled on July 31,2012. Industrialists, economists and analysts would want the RBI to cut the repo rate on this day. The repo rate is the interest rate at which RBI lends to the banks.
The first quarter review of the monetary policy is scheduled on July 31,2012. Industrialists, economists and analysts want the RBI to cut the repo rate on this day. The repo rate is the interest rate at which RBI lends to the banks.
So what is the idea behind this? When the RBI cuts the repo rate it is trying to send out a signal to that it expects the interest rates to come down in the months to come. If the banks think that the signal by the RBI is credible enough then they lower the interest rate they pay on their deposits. They also lower the interest rates they charge on their long term loans like home loans, car loans and loans to businesses. With people as well as businesses borrowing and spending more it is expected that the slowing economic growth will be revived.
That’s how things are expected to work in theory. But economic theory and practice do not always go together. The trouble is that even if the RBI cut the repo rate right now, the credibility of the signal would be under doubt, and banks wouldn’t cut interest rates. This is primarily because like Ilaiyaaraja, Subbarao and the RBI also do not work in isolation.
More loans than deposits
The incremental credit deposit ratio of the banks in the six month period between December 30,2011 and June 29,2012, has been 108%. What this means that during this period for every Rs 100 that banks have borrowed by raising deposits, they have loaned out Rs 108. Hence, banks have not been able to match their deposits to loans. They have been funding their loans out of deposits they had raised in periods previous to the six month period considered here. Given the shortage of deposits that banks are facing it doesn’t make sense for them to cut the interest rates on their deposits, even if the RBI were to go ahead and cut the repo rate. And if they can’t cut interest rates on their deposits there is no way the banks are going to cut interest rates on their loans. But why are banks facing a shortage of deposits?
The oil subsidy for this year is already over
The budget for the year 2012-2013 had made a provision of Rs 43,580 crore for oil subsidies. This provision is made to compensate the oil marketing companies (OMCs) Indian Oil Corporation, Bharat Petroleum and Hindustan Petroleum, for selling diesel, kerosene and LPG at a loss. Four months into the financial year the government has already run out of this money. The government has compensated the OMCs to the extent of Rs 38,500 crore for products at a loss in the last financial year (i.e. the period between April 1, 2011 and March 31,2012). This payment was made in this financial year and hence has been adjusted against the Rs 43,580 crore provisioned against oil subsidies in the budget for the current financial year.
The OMCs continue to sell these products at a loss. In the month of April 2012 they lost around Rs 17,000 crore by selling diesel, kerosene and LPG at a loss. In the last financial year the government compensated 60% of this loss. The remaining loss the government forced the oil producing companies like ONGC and Oil India Ltd, to compensate. So using the rate of 60%, the government would have to compensate around Rs 10,200 crore for the losses faced by the OMCs in the month of April. Add this to the Rs 38,500 crore of payment that has already been made, we end up with Rs 48,700crore. This is more than the Rs 43,580 crore that had been budgeted for.
The OMCs continue to lose money
The losses made by OMCs have come down since the beginning of the year. In April, the OMCs were losing Rs 563crore per day. A recent estimate made by ICICI Securities puts the number at Rs 355crore per day. At this rate the companies will lose around Rs 130,000 crore by the end of the year. Even if oil prices were to continue to fall the companies will continue losing substantial amount of money.
All this will mean an increase in expenditure for the government as it would have to compensate these companies to help them continue their operations and prevent them from going bust. An increase in expenditure would mean an increase in the fiscal deficit. Fiscal deficit is the difference between what the government spends and what it earns. The fiscal deficit for the current year has been budgeted to be at Rs 5,13,590 crore. It is highly unlikely that the government will be able to meet this target, given the continued losses faced by the OMCs.
Further borrowing from the government would mean that the pool of savings from which banks and other financial institutions can borrow will come down. This means that to banks will have to continue offering higher interest rates on their fixed deposits and hence keep charging higher interest rates on their loans.
High inflation
The consumer price index (CPI) inflation for the month of May stood at 10.36%, higher than the 10.26% in April. This is likely to go up even further in the days to come. The WPI inflation coming for the month of June has come in at xx%. And this is likely to push the CPI also in the days to come. CPI inflation will be pushed further given that the government increased the minimum support price on khareef crops from anywhere between 15-53% sometime back. These are crops which are typically sown around this time of the year for harvesting after the rains (i.e. September-October). The MSP for paddy (rice) has been increased from Rs 1,080 per quintal to Rs 1,250 per quintal. Other major products like bajra, ragi, jowar, soybean, urad, cotton etc, have seen similar increases. Also, after dramatically increasing prices for khareef crops, the government will have to follow up the same for rabi crops like wheat. Rabi crops are planted in the autumn season and harvested in winter. This will further fuel food inflation. Food constitutes around 50% of the consumer price index in India. In this scenario of higher inflation it will be very difficult for the RBI to cut the repo rate. And even if it does cut interest rates it is not going to be of any help as has been explained above.
To conclude
The way out of this mess is rather simple. Oil subsidies need to be cut down. That is the only way the government can hope to control its fiscal deficit. If things keep going the way they are I wouldn’t be surprised if the fiscal deficit of the government even touches the vicinity of Rs 6,00,000 crore against the budgeted Rs 5,13,590 crore.
Only once the government gives enough indications that it is serious about controlling the fiscal deficit, will the market start taking the interest rate policy of the RBI seriously. Before that even if the RBI were to cut interest rates it wouldn’t have an impact.
For Duvvuri Subbarao to make melody like Ilaiyaraaja does a lot of things which are not under his control need to come together. Ilaiyaraaja has control over the people he works with. He can tell his musicians what to play. He can ask his singers to sing in a certain way. He can ask his lyric writer to write a certain kind of song. And so on. Subbarao does not have the same control over the other players in the economy.
So in the meanwhile it is safe to say that try he might as much to make melody like Ilaiyaraaja, chances are he is likely to come up a song Baba Sehgal once made. It was called “Main Bhi Maddona”. For those who have heard the song will know that melody has never been “murdered” more.
(The article originally appeared on www.firstpost.com on July 16,2012. http://www.firstpost.com/economy/post-wpi-subbaraos-music-may-be-more-baba-sehgal-than-ilaiyaraaja-378448.html)
Vivek Kaul is a writer and can be reached at [email protected]