A happy ending- Schooling and beyond

Tuesday, my son joined the IIT, Chennai. It was a satisfying moment for us. The new batch size was around 800 odd students. The students were from all over the country, with arrivals from Andhra Pradesh perhaps being the single largest chunk. Being the first day of ‘orientation’, almost all the children were accompanied by one or both parents.
I noticed something interesting. Almost without exception, every parent seemed to be from a modest middle class background. The cars in the parking lot of IIT were few (perhaps local Chennai crowd) and most had come by train to Chennai and then by autorickshaw / call taxi to IIT. For 800 odd families, there were less than a 100 cars!
My mind went back to the day my children were admitted at Bombay Scottish School. I felt like a fish out of water. Almost every parent was from the upper echelons of society, working in a foreign bank or a multinational company or a businessman or a rich politician. There was no ‘smell’ of ‘middle class’ and I felt oddly out of place. Most of the parent crowd seemed to know / recognise each other. I was perhaps sticking out like a sore thumb.
Conclusion?
A school like Bombay Scottish attracts the rich and famous and merit is not a driver. The parents of the children who study at Bombay Scottish have already ‘made it’. The children here will probably end up going to colleges abroad and life has already been set up for them. A place like IIT attracts the best of talent. And it those students who get admitted to the IIT are going to ‘make it’. Their parents have perhaps struggled with life and sacrificed a lot to get their kids through the grind. They have shifted all their dreams to their children.

Am I making a 'sweeping' conclusion? I see this rich school poor school syndrome happening again and again. My children left Bombay Scottish in 1999 and the last ten years happened in Chennai. They went to a school names PS Senior Secondary School and my son shifted to a school called Padma Seshadri in 11th standard. The reason for the shift was that the earlier school hated students going to any classes for so called 'entrance' exams. My daughter finished her schooling at PS Senior and is currently doing her Law at ILS Law College Pune. She again had a choice of going to one of the National Law Schools, but opted for ILS Pune.

RBI vs India Inc

THE DEBASEMENT OF THE RUPEE

Inflation is perhaps the biggest destroyer of wealth. Imagine if I had put aside a sum of Rs.100 ten years ago and earned around 7% p.a. as a return. Today, I would be having around Rs.200/-. Ten years ago, I could buy dal at under Rs.30/- a kg/- or buy a litre of petrol at under Rs.25/-. Today, the Dal is close to 100/- a kg and petrol is over 60/- a litre and climbing. Of course, vegetable and food prices have more than tripled in this time. In essence, what I saved ten years ago, is today worth less than half. Half has been destroyed because I did not spend it. More important, my assumptions of ten years ago, that what I put aside would suffice for me today, have gone terribly wrong. If I cannot earn additional income (Ten years ago, my plan was to stop having to go to work at this stage in my life, presuming that my savings were enough) I have to scale down my expectations or sell off some other assets.
Inflation is not going to stop. To me, the biggest damage has been done with the increase in the interest rate on the Savings bank deposit, by the RBI. It virtually amounts to the regulator giving up on inflation. I would, in their place, have reduced the savings deposit rate to zero! Till a few years ago, savings bank balances beyond one lakh rupees would not earn interest on the excess. Today, banks pay interest on everything. The result of this move by RBI is for people to create a higher benchmark in terms of expectation of returns. If the savings rate had been brought down to zero, not many (barring some vested interest groups) would have protested. At the same time, it would have had the magical effect of lowering people’s expectations. Today, the Savings Bank interest rate has become a kind of a low point of expectation. Naturally, to park money anywhere else, we need higher returns. If the savings interest rate was zero, our expectation of return from other instruments or avenues would have been lower.
Similarly, the RBI has hiked interest rates across the board. Now we are seeing ten year instruments being floated with yields of 12% p.a. and above! It is not as if the banks are flush with money and the RBI will reduce credit offtake due to this move. In fact, the banks do not have enough money to lend. And a company will not stop borrowing for its regular needs simply because the interest rate has gone up by a couple of percentage points. In fact, due to lack of additional supplies coming on, in most industries the competition is minimal. This gives the companies to pass on the increased interest rate to the buyer. Inflation gets worse due to this vicious cycle.
What will get impacted is capital expenditure. Large projects will get postponed due to the high interest rates.
In this environment, the villain of the piece is retail lending. It continues to grow unabated. A couple of percentage increase in interest rates has not deterred spending. Durables and automobile industries are growing at record rates. Most of this growth is on account of credit purchases. Of course, it does help these industries, but these goods are virtually immune to price hikes in today’s environment of unfettered ambition and consumerism. Banks are continuing to grow this portfolio unmindful of credit quality. The race for market share and the gambler like urge to keep growing the ‘book’ has diverted focus to size rather than quality. Many banks and lenders have outsourced even the critical function of origination of loans to third parties. Obviously, this will result in mounting bad debts. I am seeing consumer portfolios that have gone bad, being sold at ten percent or lower of the outstanding value to other banks or asset reconstruction companies. Consumer activism and a benign regulatory attitude to defaulters have made it very easy for the individual to default and not impact his lifestyle in any way. Smart borrowers are using this aspect to run up loans, negotiate them after deliberate default and continue. I do not think that the credit bureau scores will have much impact in the near term, so long as it is used only as a pricing tool rather than a denial of credit mechanism.
Credit is a useful mechanism to bring buyers and sellers together. However, when buyers are more than the sellers, credit will only serve as a tool to push prices up. As the old saying goes, when credit has to be ‘sold’ it will end up as a bad debt.
This cycle will have its conclusion either by supply catching up with demand or by prices going up to an extent that at some point buyers will vanish / reduce dramatically. Supply does not look like it is going to catch up in a hurry. The most likely thing seems to be that we will go through a phase of rising prices. To me, this is a scary situation. We will see apparent prosperity, without increase in number of jobs. We will see fixed income earners (pensioners/retired persons) struggle to make ends meet. Income disparities will rise to record levels not seen before. Rising interest rates cannot benefit all. Only to those with continuing inflow of money, will rising interest rates be of gain. If I have already locked in my money, I cannot take advantage of rising interest rates. Even if I go through the mutual fund rate, I will not gain. As interest rates rise, we will see the prices of assets fall.
So, what do we do? One assumption I would like to make is that the RBI will stop its misguided driving up of interest rates sooner rather than later. I will accept that inflation in India is going to have a run rate of eight to ten percent per annum given the fact that our combined state central fiscal deficit will remain in double digits and the base savings rate having been raised to four percent. I will preserve my assets in as much short term assets as possible. I will wait for a stock market correction to add to my equities portfolio. What extent? Maybe another twenty percent fall from here or the same levels two years down the road (assuming that profit growth would still be around 15% p.a). Postpone most of my durable purchases and push back the buying of my second home. Put some more money in to Gold ETF’s. Follow the Shakespearean dictum of ‘Neither a lender nor a borrower be”. I would look out for fixed deposits / bonds to park some of my money. Liquid funds are back in fashion, with decent returns. I will avoid Income funds for now; till I am sure that the RBI is done with jacking up the interest rates.
What I have outlined is perhaps a pessimistic outlook. However, if I can be prepared for this, I can only have positive surprises. I am still not so pessimistic that we will go all the way to hyperinflation or a severe bout of stagflation. I bank on the domestic entrepreneurs to fight their way out of this, rather than expect the government of India to do anything constructive. The politicians are busy fighting their survival battles and economics, unfortunately has no place in that.

Reel Estate

REEL ESTATE.. OUT OF FLAVOUR

Everyone seems to be of the opinion that the real estate prices in the metro cities is likely to correct downwards significantly. This is also borne out by many large projects (esp in cities like Chennai) that kicked off in 2007-08 madness, getting delayed in execution. In fact at Chennai, I see many projects still selling at prices below what they were launched at, apart from changes in plans that involve change in usage, cutting corners with regard to facilities etc.
The interesting dichotomy I see is with regard to the size and scale of the projects. In metro cities, the large projects tend to be on the fringes of the city or in ‘new’ growth areas, due to availability of large land pieces. Within the city, the supply of new housing stock is rather limited and the demand strong. So we have a situation where prices in the heart of many cities, for small projects, have risen dramatically. At the same time, prices have slumped in most large projects. Of course, when I mean slumped, it is still not juicy or attractive enough to become bargains, yet.
So what is holding up the prices? I see unsold stock, incomplete projects and steady prices. In 2007-08, most of the demand that came in was of a speculative nature, where hot money chased quick and easy returns. Book a flat at the ground breaking ceremony time at base price. As progress happens, the prices start to rise. Sell it off before completion and enjoy full profits with less than full investment. The banks and housing finance companies also contributed to this speculative frenzy by giving loans of 100% or more (some banks gave on furniture also!).
The 2008-09 crises saw hot money rushing for the exit. Prices fell, especially in the large projects in outlying areas. Projects got delayed, reshaped and prices stagnated. Many overpriced projects had to correct prices in a big way.
Now (two years since the stagnation) there still does not seem to be much recovery in prices. Projects still take time to sell out. Inflation in two years has been high, which means that the costs of construction have. So, the days of superprofits for the builders are coming down. I recall balance sheets of companies like DLF showing net profits of over 70% of sale value! It still has to come down to reasonable levels.
For the investors, this means that real estate stocks are untouchable yet. Many of the real estate companies are raising money through privately placed paper at high interest rates. Some companies are trying to reschedule their obligations. The debt on the balance sheet of most real estate companies is still at uncomfortable levels.
We also had a phase of euphoria with almost every real estate company projecting huge returns on “SEZ” development. Most now want to give back the land or change the use to something else! Unless there is corruption, it is unlikely that the usage would be allowed to be changed from “SEZ” to ‘commercial’. So, I would keep away from the SEZ dreamers for a few more years.
The shares of most companies still seem to be holding on (of course far away from the stratospheric levels of 2008-09). And given the lack of transparency and periodic bad news from one company or the other in the sector (Unitech and the 2G scam for instance) investors have no reason to put money in shares in this sector. Despite that, prices have not crashed nor have institutional investors ditched this sector totally.
The one inference I draw from all this is that there still is some serious money that is backing this sector. Is it legitimate money or money that has found its way through devious routes that is holding up this sector? To me the biggest risk this sector has is a fear or feeling of instability in the political environment. A scare from that direction can perhaps bring about a real slump in the sector.
As regards land, prices fell and then gradually recovered. Yes, large deals are not happening, but small investments in land continue to happen. Given the reducing retail participation in stocks, there is a diversion of money to real estate and precious metals. Tier two cities are witnessing firm to rising land prices.
The other interesting perspective is on the rentals. Commercial properties across most large cities have seen a steep decline in rentals. At the same time, an oversupply situation seems to be correcting itself with the withdrawal of a lot of projects. This perhaps implies stable rental situations. The one interesting fall out is that the newer properties command significantly higher rentals. Apart from offering better infrastructure, the new properties have a very large hidden premium. The carpet area to built-up ratio in new projects is significantly less. Regulators are continuing to play footsie with the builders by refusing to mandate uniform standards in measurement standards for real estate.
I would watch out and an eye on companies that are able to hold on to commercial properties and earn rentals from that. This seems to be a good strategy. Apart from that, I would also like to revisit companies with low to zero debt and with low profit margins. These are the companies that will do well when the next boom in real estate happens. As regards timing, difficult to take a call as to when we would see a revival in this sector. But this is one sector (if we can exclude the governance issues) where there could be value picks.

R. Balakrishnan
(balakrishnanr@gmail.com)
May 27th, 2011

(This was published in the 14th July issue of Moneylife)

Inflated economy, debased currency

(This appeared in a recent issue of Moneylife. )

THE DEBASEMENT OF THE RUPEE

Inflation is perhaps the biggest destroyer of wealth. Imagine if I had put aside a sum of Rs.100 ten years ago and earned around 7% p.a. as a return. Today, I would be having around Rs.200/-. Ten years ago, I could buy dal at under Rs.30/- a kg/- or buy a litre of petrol at under Rs.25/-. Today, the Dal is close to 100/- a kg and petrol is over 60/- a litre and climbing. Of course, vegetable and food prices have more than tripled in this time. In essence, what I saved ten years ago, is today worth less than half. Half has been destroyed because I did not spend it. More important, my assumptions of ten years ago, that what I put aside would suffice for me today, have gone terribly wrong. If I cannot earn additional income (Ten years ago, my plan was to stop having to go to work at this stage in my life, presuming that my savings were enough) I have to scale down my expectations or sell off some other assets.
Inflation is not going to stop. To me, the biggest damage has been done with the increase in the interest rate on the Savings bank deposit, by the RBI. It virtually amounts to the regulator giving up on inflation. I would, in their place, have reduced the savings deposit rate to zero! Till a few years ago, savings bank balances beyond one lakh rupees would not earn interest on the excess. Today, banks pay interest on everything. The result of this move by RBI is for people to create a higher benchmark in terms of expectation of returns. If the savings rate had been brought down to zero, not many (barring some vested interest groups) would have protested. At the same time, it would have had the magical effect of lowering people’s expectations. Today, the Savings Bank interest rate has become a kind of a low point of expectation. Naturally, to park money anywhere else, we need higher returns. If the savings interest rate was zero, our expectation of return from other instruments or avenues would have been lower.
Similarly, the RBI has hiked interest rates across the board. Now we are seeing ten year instruments being floated with yields of 12% p.a. and above! It is not as if the banks are flush with money and the RBI will reduce credit offtake due to this move. In fact, the banks do not have enough money to lend. And a company will not stop borrowing for its regular needs simply because the interest rate has gone up by a couple of percentage points. In fact, due to lack of additional supplies coming on, in most industries the competition is minimal. This gives the companies to pass on the increased interest rate to the buyer. Inflation gets worse due to this vicious cycle.
What will get impacted is capital expenditure. Large projects will get postponed due to the high interest rates.
In this environment, the villain of the piece is retail lending. It continues to grow unabated. A couple of percentage increase in interest rates has not deterred spending. Durables and automobile industries are growing at record rates. Most of this growth is on account of credit purchases. Of course, it does help these industries, but these goods are virtually immune to price hikes in today’s environment of unfettered ambition and consumerism. Banks are continuing to grow this portfolio unmindful of credit quality. The race for market share and the gambler like urge to keep growing the ‘book’ has diverted focus to size rather than quality. Many banks and lenders have outsourced even the critical function of origination of loans to third parties. Obviously, this will result in mounting bad debts. I am seeing consumer portfolios that have gone bad, being sold at ten percent or lower of the outstanding value to other banks or asset reconstruction companies. Consumer activism and a benign regulatory attitude to defaulters have made it very easy for the individual to default and not impact his lifestyle in any way. Smart borrowers are using this aspect to run up loans, negotiate them after deliberate default and continue. I do not think that the credit bureau scores will have much impact in the near term, so long as it is used only as a pricing tool rather than a denial of credit mechanism.
Credit is a useful mechanism to bring buyers and sellers together. However, when buyers are more than the sellers, credit will only serve as a tool to push prices up. As the old saying goes, when credit has to be ‘sold’ it will end up as a bad debt.
This cycle will have its conclusion either by supply catching up with demand or by prices going up to an extent that at some point buyers will vanish / reduce dramatically. Supply does not look like it is going to catch up in a hurry. The most likely thing seems to be that we will go through a phase of rising prices. To me, this is a scary situation. We will see apparent prosperity, without increase in number of jobs. We will see fixed income earners (pensioners/retired persons) struggle to make ends meet. Income disparities will rise to record levels not seen before. Rising interest rates cannot benefit all. Only to those with continuing inflow of money, will rising interest rates be of gain. If I have already locked in my money, I cannot take advantage of rising interest rates. Even if I go through the mutual fund rate, I will not gain. As interest rates rise, we will see the prices of assets fall.
So, what do we do? One assumption I would like to make is that the RBI will stop its misguided driving up of interest rates sooner rather than later. I will accept that inflation in India is going to have a run rate of eight to ten percent per annum given the fact that our combined state central fiscal deficit will remain in double digits and the base savings rate having been raised to four percent. I will preserve my assets in as much short term assets as possible. I will wait for a stock market correction to add to my equities portfolio. What extent? Maybe another twenty percent fall from here or the same levels two years down the road (assuming that profit growth would still be around 15% p.a). Postpone most of my durable purchases and push back the buying of my second home. Put some more money in to Gold ETF’s. Follow the Shakespearean dictum of ‘Neither a lender nor a borrower be”. I would look out for fixed deposits / bonds to park some of my money. Liquid funds are back in fashion, with decent returns. I will avoid Income funds for now; till I am sure that the RBI is done with jacking up the interest rates.
What I have outlined is perhaps a pessimistic outlook. However, if I can be prepared for this, I can only have positive surprises. I am still not so pessimistic that we will go all the way to hyperinflation or a severe bout of stagflation. I bank on the domestic entrepreneurs to fight their way out of this, rather than expect the government of India to do anything constructive. The politicians are busy fighting their survival battles and economics, unfortunately has no place in that.