I am very excited to bring you this newsletter on Valuation, a topic I am very intrigued with. This is easily one of my most favorite ones I’ve written along with the 10 Trillion Indian Economy and Digtal Public Goods. It focuses mainly on surface level metrics to filter out the best companies based on valuation. This isn’t a deep dive on how to study moat, quality of earnings, forecasting earnings or forensic accounting but it’s an easy point to start your investing research journey with. Hope you like reading it as much as I loved researching it and would love to get your feedback. I’ll link the other topics mentioned above once I publish them so stay tuned 🙏

10X Pre-tax Earnings: Time entry

A favourite of Warren Buffett, most of his largest and best deals like Coca-Cola, American Express, Walmart and Apple have followed this ratio. Pretax earnings or PBT/EBT (Profit/Earnings before taxes) is considered to be a good valuation for entry into fundamentally strong and growing companies with long history. Prices far above 10x EBT is a good time to sell. But why favor pretax earnings over other metrics? Post-tax earnings dont reflect business fundamentals. Taxes can change due to factors beyond business fundamentals, such as tax laws in different geographies, capital structure changes etc. However, two major risks are quality and valuation. Quality risk/Value trap = purchasing low-quality asset at a bargain, valuation risk = expensive high-quality asset. This rule is primarily intended to mitigate valuation risk after quality risk has been addressed. Essential to avoid low-quality company at cheap prices.

FCF/EV: Free Cash Flow Yield

Free Cash Flow = Operating cash flow – (Capex+ Advances for capex) – Investment in subsidiaries, intercorporate deposits.

The higher the yield, the better. FCF is the actual money a company makes after paying for expenses and assets required to operate normally. Research on Indian equities suggests, earnings growth accounts for only 14.4% of share price returns, PAT growth 47.6% returns and FCF growth 59.4%. FCF growth is by far the biggest driver of shareholder value, especially for Indian companies’ v/s using PE to value companies which ignores real cash earnings of companies.

FCF Growth has the one of the strongest correlations with share prices among popular metrics, Source: Marcellus Investment Managers, Ace Equity

Same research shows starting trailing PE can explain 0% of share price growth v/s using price to present value of expected FCF explaining 9%. While 9% is still more than 0% which shows how FCF growth is still a better metric, it also shows how little current stock prices have effect on future share price returns for Indian companies.

Starting trailing PE explains 0% of share price growth. Source: Marcellus Investment Managers, Ace Equity

Price to PV of FCF explains 9% of share price growth. Source: Marcellus Investment Managers, Ace Equity

FCF growth captures growth of a business far better than P/E does because FCF is nothing more than ROCE less the cost of capital. Therefore, healthy growth in FCF necessarily implies equally healthy growth in ROCE.

Economic Value Added: Calculate fair value

Aka economic profit, as it attempts to capture the true economic profit of a company.

EVA = Net operating profit after tax – (cost of capital x capital employed) whereapital employed = Debt + capital leases + shareholders' equity

Using this value we arrive at, Fair Value= Present Value of EVA for each year (if using previous or future estimates, similar to DCF)

However, it relies heavily on the amount of invested capital and is best suited for asset-rich, stable or mature companies. Companies with intangible assets, such as technology businesses, may not be ideal candidates for EVA evaluation, which is a big reason why just P/E ratios leads to undervaluing such companies.

Using EVA (@12% WACC) to arrive at Fair Values for high PE companies shows the undervaluation when focusing just on PE multiples, June 2010 – December 2022, outperformned the market by 33% . Source: Marcellus Investment Managers

Most of these high P/E companies at a 45% discount to fair value. Bucket 1 is capital goods companies that generated negative/zero EVA due to the capex downturn in India from FY11-22. They had a negligible fair value in 2010, despite being valued at billions by the stock market. Bucket 2 had asset-light FMCG/consumer-facing companies, fairly or overvalued. Bucket 3 had asset-light consumer-facing and FMCG companies, significantly undervalued. Market rewards consistency of growing EVA. The higher the ROCE, the bigger this surplus is and when reinvested efficiently year after year, this reinvested surplus snowballs to create wealth for shareholders.

Combined with EVA, ROCE can filter stocks that give even better returns. Source: Marcellus Investment Managers

CFO/EBITDA :Real earnings

EBITDA is profits from core business activities but on accrual basis (recognition when sale is made). CFO to EBITDA gives a better picture on how much cash the company is generating from EBITDA since CFO works on cash basis (recognition when cash is received). ~0.6 and up is considered to be a good value especially for B2B businesses that shows the firm has less money stuck in working capital. B2C companies have very low trade receivables since they receive cash immediately and thus reflect very high CFO/EBITDA (>~70%).

We use EBITDA instead of PAT (Profit After Tax) to make sure other income from non-core business activities and taxation doesn’t distort the view and lets us compare companies across sectors or industries. Once you filter the companies, you can then further study their inventory and receivables as a % of sales to understand why the ratio is low or high compared to peers. Higher these percentages, poorer the working capital and worse the ratio.

An increase in earnings means an increase in Net Worth but not in cash distributable to the owners. As long-term investors, the hope is for a company to eventually return more cash than invested, typically in the form of dividends. However, if majority of the earnings are in the form of non-cash assets like receivables, then the company can’t sustainably return cash to investors. For example, a $1 increase in net worth can be achieved by a $0.50 increase in accounts receivable and a $0.50 decrease in accounts payable, without affecting the company's cash on hand.

Management can choose whether to reinvest excess cash or return it to owners, and they should only reinvest when they expect to earn attractive returns. Thus, high CFO/EBITDA ratios and high reinvestment rates can be a great way to identify cash generating companies poised for growth.

CWIP to Net Block :Huge capex and depreciation adjusments

Net Block = Cost of property, plant, equipment (aka. gross block) – Depreciation

Capital work in progress (CWIP) represents costs incurred on a fixed asset, which is still under construction.

Using filters like CWIP > Net block 3/5 years back can be easy ways to filter companies that have currently undertaken massive capex. However, CWIP can’t be always verified by the auditor and depends on the management. Additionally, depreciation can’t be charged on it. Companies where CWIP as a percentage of current gross block is consistently very high consistently over 3-5Y time periods should be avoided. Focus on companies that aren’t just doing capex but also consistently converting CWIP into gross block. To compare capex to total asset base, CWIP to gross block is better, to compare capex to the companies net asset value (accounting for depreciation) CWIP to net block is better.

EBIT/EV & ROCE : Magic Formula

Joel Greenblatt annualized 17.1% CAGR in 1988-2020 using this (v/s SP500 9.2%) and has been replicated (in backtests) to be successful even in Indian equities for 2002-2020 @ 30% CAGR (v/s Nifty50 12.7%), consistently outperforming Nifty50 in every 5Y period for the 18Y backtest period.

The strategy is to invest in companies with high ROCE (EBIT/(Net Fixed Assets + Working Capital)) and high earnings yield (high EBIT/EV, means a bargain price because low debt & high income).

Net fixed assets = fixed assets - depreciation and any liabilities associated with the asset, gives a more accurate sense of the real value of a company's assets.

Working capital = current assets minus current liabilities, gives a picture of whether the company is likely able to continue operations in the short term.

Even EBITDA/EV aka the enterprise multiple seems to be an effective measure of capturing such value premium based on research, outperforming both on raw and risk-adjusted returns. It captures a higher degree of systematic mispricing than other value metrics like book-to-market, earnings-to-market etc.

Combine ranking for both and invest in a basket of the top 25, equal-weighted. Financials are excluded because their business model are different and hence these ratios are inappropriate and same for negative Net Worth companies because negative Net Worth amplifies RoCE. Additionally, in cyclical and commodity sectors, you have to sell the stocks when the companies are generating peak RoCE instead of buying them. To deal with this, including companies in the universe if their last 7 years median RoCE is more than 15% can be a solution. Unfortunately, it involves an annual rebalancing by selling businesses with high Magic Formula ranks a year after purchasing them. This step is crucial because it looks for temporarily mispriced stocks in the market that will return to its mean value within a year, not quality businesses that should be held for the long term and selling within a year. This is a tax heavy event for an investor even if u hold the winners for longer than a year and losers sold at less than a year to benefit from long term and short-term capital gains tax differential.

EV/EBITDA :Acquirer’s Multiple

Outperformed the Magic Formula in US markets from 1972-2017, with the latest data being 16.1% from 1964-2020 (v/s SP500 @10.4%). The strategy bets on cheap companies, even ignoring quality, for the sake of mean reversion for long time periods.

EV = Enterprise Value = Market Capitalization + Debt – Cash

EBITDA = Earnings Before Interest, Taxes and Depreciation & Amortization

P/E ratio only looks at the residual income generated for equity shareholders and ignores debt capital and operating profitability. Stock superficially undervalued on a book value basis is recognized as being fully valued, or overvalued once its debt load is factored in. It can also be tricky for loss-making companies, startups, and cyclical companies but AM can be computed even for firms reporting net losses.

Earnings Yield (EY) and ROIC/ROCE from Magic Formula and how focusing just on EY gives better risk adjusted returns, backtested on US stocks with Mcap>$400M, from 1973 to 2012. Source: Euclidean Technologies

However, it overlooks cash flow nature and expenditure, including capex and interest. EV/EBITDA can also be misleading for capital-intensive businesses like airlines and auto ancs (which typically sell at low EV/EBITDA ratios). While Buffet is not fond of using EV independently because depreciation irrespective of recognition is a real cost and EBITDA can be manipulated using capitalized expenses (like Enron did), Tobias Carlisle, who popularized the ratio, believes that fair companies at wonderful prices beat wonderful companies at fair prices because great businesses don't stay great. They only look great at the top of their business cycle. Mean reversion pushes great business back to average especially when time periods are 20 years or more.

Shareholder Yield

=Dividend yield (over previous 12 months - special dividends) + % net share buybacks over the previous 12 months.

Larger stocks have historically underperformed over the long term which means there’s room for improvement for the large market cap stocks which as a basket are considered to be more efficient. Research shows large-cap companies that return value to shareholder in terms of both dividends and buybacks usually outperform the rest of the market. Companies repurchase their own shares when the stock is undervalued, which sends a message to investors that the management believes its stock is trading below intrinsic value. Additionally, shares are sometimes bought back to offset dilution from employee stock grants. However, repurchases can also be used to manage or boost earnings per share. Investors should focus on companies repurchasing stock for undervaluation reasons, rather than for managing EPS or dilution.

Gross Buyback Yield = Total share repurchases / market capitalization

Net Buyback Yield = (Total share repurchases - total share issuance) / market capitalization

Focus on “net” buyback yield, which takes share issuance into account alongside buybacks.

Earnings quality is a huge factor in choosing stocks with higher buyback yield. Can be a 5.5% CAGR loss on choosing companies with low quality of earnings. Source: OSAM Research

Value is a huge factor in choosing stocks with higher buyback yield. Can be a 10.2 CAGR loss on choosing the most expensive ones. Source: OSAM Research

However, the same research also shows buying such companies at expensive valuations can be brutal and hence shareholder yield should ideally combined with other value factors to ensure a good price and quality of earnings growth to ensure continual rising yields. This research was conducted on stocks in US markets, further research needs to be done for Indian markets to check their validity considering Indian markets have different correlations between value and returns as shown by FCF yield and also systemically different dividend yields.

Residual Income

Financial companies dont use 3 parts of the traditional cash flow model which is why they require to be valued differently. Debt in Financial Services firms is more like raw material that is used to make loans and earn Net Interest Margin (NIM). As a result, the payments made to debt providers are part of operating expenses rather than interest payment. Measuring reinvestment needs for Financial Services firms is an issue as they primarily invest in intangible assets such as brands and human capital, and not in fixed assets. Also, working capital cannot be calculated in the traditional way, as a large proportion of a bank's balance sheet would fall either into current assets or current liabilities Thus, neither the free cash flows nor the reinvestment rate, as used for non-financial firms, can be used. A great alternative is the residual income. calculated as,

Intrinsic Value of Equity = Equity capital invested currently (i.e. current book value) + Present value of Expected excess returns to Equity investors (i.e. ROE – COE)

Sources:

https://seekingalpha.com/article/4477006-jpmorgan-chase-jpm-stock-buffett-10x-pretax-rule

https://marcellus.in/blogs/what-they-dont-tell-you-about-high-p-e-stocks/ 

https://pages.stern.nyu.edu/~adamodar/pdfiles/valn2ed/ch21.pdf

https://marcellus.in/newsletter/kings-of-capital/a-simple-approach-to-valuing-financial-services-companies/

https://www.investopedia.com/terms/e/eva.asp

https://twitter.com/10kdiver/status/1411737929387593729

https://youtu.be/HU3g-nohX4o

https://www.oldschoolvalue.com/investing-strategy/acquirers-multiple-value-quest/

https://www.oldschoolvalue.com/investing-strategy/the-best-value-stock-screening-ratios/https://www.brokenleginvesting.com/acquirers-multiple/

https://financialtales.home.blog/2020/05/04/joel-greenblatts-magic-formula-in-the-indian-context-does-it-work/

https://greenbackd.com/2015/04/07/is-simpler-better-quantopian-tests-the-acquirers-multiple-and-joel-greenblatts-magic-formula/

https://alphaarchitect.com/2014/10/23/quantitative-value-research-enterprise-multiple-em-factor/

https://alphaarchitect.com/2015/11/24/the-enterprise-multiple-international-evidence/

https://alphaarchitect.com/2016/11/value-investing-using-enterprise-multiples-is-the-premium-due-to-risk-andor-mispricing/

https://marcellus.in/wp-content/uploads/2020/06/Investing-Through-a-Crisis-A-handbook-from-Marcellus.pdf 

https://www.osam.com/Commentary/shareholder-yield-a-differentiated-approach-to-an-efficient-market

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. Nothing on this Blog constitutes investment advice, performance data or any recommendation that any security, portfolio of securities, investment product, transaction or investment strategy is suitable for any specific person. From reading this Blog we cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you, so any opinions or information contained on this Blog are just that – an opinion or information. You should not use this Blog to make financial decisions and we highly recommended you seek professional advice from someone who is authorised to provide investment advice.

Indian 1Y T-bill yield was 6.92% as of April 1, 2023. Source: Marketwatch.com, RBI

This means that Govt. has to pay 6.92% interest to borrow money for 1 year, almost the 2^nd highest rate since 2015. Indian Govt. 1Y bonds are considered to be the safest asset class for the domestic investor & consequently for any borrower other than Govt., they have to cough up a yield better than what the safest asset can offer. Thus, cost of funding for all corporates have exponentially shot up in the last few years. Additionally, Indian Govt.’s already massive fiscal deficit balloons up even more with a larger interest payment on bonds, which trickles down for the citizens as a massive financial burden in the form of higher inflation (which corporates will pile on too to maintain their profit margins since their cost of funding have gone up) & higher taxes. Both the quantum of savings post taxes & the purchasing power of said savings have gone down. But this also provides a somewhat rare opportunity because inflation is at 6.44% which means when invested correctly, money can grow at a much faster rate than the reduction of purchasing power.

The 2020 Covid pandemic led to widespread lockdowns & supply chain disruptions, which caused a severe liquidity crisis worldwide. In response, central banks, including RBI, lowered interest rates & provided liquidity to the markets by pumping money into the financial system. RBI introduced “Targeted Long Term Repo Operations (TLTRO)” program to provide support to banks wherein 73,000 Crores (~$10 billion USD) were provided to banks at rates as low as 4.4%, for 3 years, to invest in specific sectors of the economy, thereby supporting economic activity during a challenging time. These funds are now set to mature by the end of April, which means that banks will have to repay the borrowed amount. If banks are unable to repay the borrowed amount, it could lead to a liquidity crunch & impact the overall financial system. However, if banks are able to repay the funds, it could lead to a reduction in liquidity in the markets.

73,000 Crore worth bank loans from RBI set to expire by April 2023. Source: RBI

Currently, banks are parking this liquidity back with RBI at 6.25% in a “Standing Deposit Facility” discount window, which gives them 1.85% i.e.,1,300 crore rupees of “free” money. However, with the end of TLTRO, banks will lose this free interest, & have to borrow from the market, where rates are climbing rapidly. Short-term money, such as commercial paper & money markets, is already becoming more expensive for banks & corporates, rates climbing close to 8%. Even HDFC Bank which is considered to be the safest private bank in India, is paying 7.8% for a 300-day borrowing. Banks are raising deposit rates, which will soon lead to an increase in lending rates. The pace of deposit rate hikes is accelerating, & lending rates are increasing even faster.

Median lending & deposit rates for Indian banks, Source: RBI, CapitalMind

So where’s the opportunity here ?

Fixed income can be one path. Rates are expected to continue in the current range even if not shoot up exponentially, especially if inflation remains in its current elevated range. In the short term, bonds above 6 months duration yield at least 7% which means a good ultra-short/ low duration fund can generate inflation beating returns. You can even invest in shorter duration Govt. T-bills directly from RBI Retail direct platform. With the recent amendment removing indexation benefits for debt funds, longer term investments in interest risk assets need to be re-assessed to check if they can provide inflation beating returns when adjusting for expenses, taxes and risk.

Usually, stock markets suffer a lot due to interest rate hikes due to corporate leverage but this time, industrial leverage isn’t that high considering 5Y annualized credit growth for industrial loans is 12.88% v/s 16.71% for retail loans, loans to NBFCs at 27.92% & 14.81% for housing loans.

However, the rising interest rates & rapid growth in retail loans from both banks & NBFCs means chances of NPAs in is much higher now. Loans to start-ups, SMEs & new business stand a higher probability of default now, which also means that newer loans will be disbursed with less ease due to higher cost and risk. Liquidity especially for leveraged & new/small firms has now dried up & this trend will continue. This means the established corporate monoliths with a proven track record for profitability with low leverage will continue to dominate their industries, get bigger & usurp more market penetration from smaller, newer & unorganized players. Fundamentally robust companies & their stocks stand to soar higher than ever.

Thirdly, insurance premiums might go up for new insurers the higher the interest rates go up so if u expect interest rates to continue to rise this might be a good time to lock in rates for new plans. Finally, if you can do it, investment in yourself by upskilling is the best investment you will ever make no matter what macros are changing in global economy.

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. Nothing on this Blog constitutes investment advice, performance data or any recommendation that any security, portfolio of securities, investment product, transaction or investment strategy is suitable for any specific person. From reading this Blog we cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you, so any opinions or information contained on this Blog are just that – an opinion or information. You should not use this Blog to make financial decisions and we highly recommended you seek professional advice from someone who is authorised to provide investment advice.

India's efforts towards financial inclusion, digitization, & rising middle-class disposable incomes have led to an increase in household savings being channeled towards the managed investments industry. Life insurance comprises the largest share (39% @ Rs. 52 Lakh Cr+), followed by mutual funds (28.4% @ Rs.38 Lakh Cr+). Due to the increasing inflation, households are now looking for investment options that offer higher returns than fixed deposits. Despite the fact that fixed deposits only make up approximately 10% of households' gross financial savings, there has been a significant shift away from bank deposits.

Managed Investment solutions gain footing on FDs, the usual trusted choice of Indians beyond gold & real estate. Source: AMFI, IRDAI, SEBI, CRISIL, NPS Trust, RBI, IMF

Rapid growth in every vertical of this industry. Source: AMFI, IRDAI, SEBI, CRISIL, NPS Trust, RBI, IMF

The managed investments industry's total assets are Rs. 135 lakh Cr. (~57% of GDP) as of March 2022, expected to 2x to Rs. 315 lakh Cr. (~74% of GDP) by March 2027. This puts the AUM in this industry already at ~79% of the AUM under FDs v/s 59% just 5 years ago showing the rapid rate of change in India’s preferred asset allocation. Evident shows domestic investors are increasingly looking at managed investment solutions as an alternative to park their money.

Share of financial savings increase. Source: RBI, CRISIL

Macro drivers for this systemic trend

India was among the fastest-growing major economies in the world before the pandemic (~6.7%, 2014-2019). The IMF predicts that India's GDP will grow faster than other economies possibly even faster than China. Indian corporates especially large ones with moat have a strong balance sheet that can help kick-start private investment, & the Production-Linked Incentive scheme incentivizes manufacturing investments. Govt.'s focus on infrastructure investments has a multiplier effect on the economy, & the well-capitalized banking sector with low non-performing assets supports economic growth. Faster digitalization provides citizens with greater access to opportunities & a platform for innovation while cutting leakages through targeted delivery of services. The current trend of financialization of savings will only increase the access to low-cost capital for corporate India to boom.

India is the fastest growing economy. Source: IMF July 2022 World Economic Update

India's per-capita income crossed $2,000 in 2021, the inflection point where income moves towards spending & investments. Additionally, the proportion of middle-income households in India is projected to reach 18.1 crore by fiscal 2030, 1.5x the number of households in the US. India also has a large young population, with about 94 crore people in the working age group, & is expected to contribute 22.5% of the incremental global workforce over the next decade. India's financial inclusion has improved significantly from 2014-2023, with the share of adults with a bank account rising from 53% to >90% due to government measures such as the Aadhaar & Jan-Dhan program. This has led to an uptick in the generally high domestic savings rate to go even higher to 29.3%, v/s global average of 26.9%.

Technology has helped surmount challenges due to India's vast geography, making it commercially nonviable to have physical footprints in smaller locations. The shift towards digital channels & e-commerce was accelerated by demonetisation, GST & the Covid-19 pandemic. The usage of technology has also resulted in a rising number of DIY investor who invest through direct mutual funds or zero cost brokers to directly invest in stocks further improving market liquidity through retail participation.

Financial Transactions by Volume. Digital transactions: RTGS (excluding interbank clearing), ECS, NEFT, IMPS, NACH, cards & prepaid instruments; Non-digital: Cheque/paper clearing, ATM. Source: RBI, CRISIL MI&A Research

Passive funds are becoming popular in India due to the better returns factoring for lower fees & expenses. Their share in AUM has grown from 3% to ~13% in March 2022, driven by institutional investors like PFs. This trend is expected to continue with individual investors also showing interest in passive funds due to the declining alpha of actively managed funds. The rise in the share of passive funds in the Indian MF industry is similar to global trends, with the US at 43% & Asia ex-Japan at 32% in 2021.

At the macro level, the pace of technology & intermediation will continue to be crucial in driving product penetration. The rise of a sticky domestic capital market, also protects the overall market from the hot flows of foreign investors. The financialisation of household savings, prospects of strong economic growth, access to capital market products, emergence of technology, growth of middle-income households, young demography, improved financial literacy, access to information, & awareness provide a boost to the investment climate. That said, financialisation of assets & its increasing flow into the managed investments industry has been backed by buoyant debt & equity markets fueled by excessive liquidity.

Some of my other favorite articles about the Indian economy -

Digital Public Goods - Aadhar, UPI, ONDC and the blistering digitization of India

Discusses some of the key DPGs of India that is transforming the Indian economy. Expansion of highway networks, tripling of local airline traffic, implementation of GST, and advancing towards a digital economy by incorporating advancements like Aadhaar (2010), UPI (2016), and ONDC (2022). These advancements will provide India with a worldwide edge in the flow of money and goods.

monthlymusings.beehiiv.com/p/dpg

US Inflation Export - Impact on India and the decline of US reserve currency hegemony

TLDR: US Yield Curve is inverted, indicating recession, massive quantitative easing /money printing has plunged the value of the US dollar in real terms due to

monthlymusings.beehiiv.com/p/usinflationbrics

India's journey to $10Trillion economy

India has a competitive advantage in knowledge-intensive, capital-light industries and that companies in these industries can become world leaders if the econom

monthlymusings.beehiiv.com/p/india10trillion

This will be my last newsletter for this year, I want to deeply thank all my readers for your continued support, insightful feedback and I hope to continue to add more value to you in the coming years. Thank you 💕🙌

Source: CRSIL December 2022 report - “The big shift in financialisation”

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. Nothing on this Blog constitutes investment advice, performance data or any recommendation that any security, portfolio of securities, investment product, transaction or investment strategy is suitable for any specific person. From reading this Blog we cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you, so any opinions or information contained on this Blog are just that – an opinion or information. You should not use this Blog to make financial decisions and we highly recommended you seek professional advice from someone who is authorised to provide investment advice.

Infrastructure development will be the gunpowder for India to become a $10trillion economy. Despite having only 45% smartphone penetration, India generates more mobile data than Europe & USA combined. Broadband usage & bank accounts increase has been accompanied by a decrease in journey times due to the construction of a highway network aided by FasTag (reduced average wait time from, 8 mins to <40 seconds). Tax reforms have revolutionized the economy, specifically the reduction in the corporate tax rate from 35% to 25% in September 2019. Despite this reduction, tax collections, particularly direct tax collections as a percentage of GDP, have hit all-time highs, GST & demonetization has rapidly increased the rate of formalization of every sector.

New sources of India’s competitive advantage, Source: Marcellus Investment Managers, Bloomberg

This is a continuation of another article I wrote on Digitial Public Goods and Indian economy. Read it here.

Digital Public Goods - Aadhar, UPI, ONDC and the blistering digitization of India

monthlymusings.beehiiv.com/p/dpg

Almost 99.9% of India’s entire adult population have an Aadhar. UPI has greatly impacted the banking & finance industries making financial transactions exponentially easier & accessible for people, especially for small & medium-sized enterprises (SMEs). The collection of data through retail apps (the moment a brand/company app say Dominos Pizza App, is installed on an Indian phone, data is scraped from SMSes, chats, locations the phone has been in etc, logged & then sent to that company) provides banks & companies with valuable information that they can use to make more informed lending decisions using machine learning algorithms. This result in lower lending rates for low-risk customers, but higher rates for those who don't display low-risk behaviours on the banking side & better targeted customer marketing on the retail sales side.

The rise of these Digital Public Goods (DPGs) will significantly ease lending for banks & non-banking financial companies (NBFCs) due to the JAM (Jan Dhan, Aadhaar, Mobile) trinity. Increased data usage & insights from consumption patterns of such a large populace using UPI when leveraged with the Account Aggregator (AA) framework & end-to-end digital access to key documents (e-Aadhar, e-sign, digilocker), will revolutionize credit underwriting & loan disbursement-collection. Lower turnaround times, increasing efficiencies & better quality of loans will mean lesser gross NPAs on a systemic scale for the country thus boosting credit cycles on a massive scale.

Open Network for Digital Commerce (ONDC), allows customers to purchase goods from any vendor in the country, regardless of whether they are on a platform. It provides customers with more options & greater control over the payment & delivery process & provides sellers with greater visibility without having to be dependent on the existing large players that enjoy visibility. A robust logistical supply chain network, enabled by FASTag & GSTN, should pave the way for a faster & more cost-effective logistics ecosystem in India. As credit cycles improve, more efficient logistics/supply chain fulfillment, & eCommerce democratization kicks in, it will become less attractive for firms to operate in the black economy. The faster formalization of the SME sector will lead to increased savings being invested in financial assets rather than physical ones.

A 2017 RBI survey revealed ~95% of Indian household savings are in real estate & gold, ~5% in financial assets. Physical assets which has usually worked well before, now isn’t expected to generate returns above the cost of capital when factoring in inflation thus signalling a massive wave of financialization of Indian savings to the tune of $1 trillion even assuming just a 1% per annum shift from physical to financial assets, reducing the cost of capital further. This means India’s cost of capital is unlikely to shoot up as rapidly as other developed economies’ have (like US, UK) in their efforts to curb inflation. Indian companies thus stand the chance to get even more competitive on the global stage.

Networking of India and polarizing of Indian economy means massive opportunity for consolidators, Source: Marcellus Investment Managers, Bloomberg, Ace Equity, IIFL Capital

India has a competitive advantage in knowledge-intensive, capital-light industries & that companies in these industries can become world leaders if the economy continues to develop. This combined with existence of dominant players in Indian markets that have consistently had ROCE>15% & sales growth>10% every year for the last decade or so with a wide enough moat, provides an opportunity for investors to ride the inevitable stock market boom since share prices compound similarly to EPS growth. Overall, there is transformative power of technology in India & its potential to drive economic growth & improve the lives of people has just started to be seen.

This is a continuation of another article I wrote on Digitial Public Goods and Indian economy. Read it here.

Digital Public Goods - Aadhar, UPI, ONDC and the blistering digitization of India

monthlymusings.beehiiv.com/p/dpg

Sources:

https://www.youtube.com/live/oOJB14ZSEp4?feature=share

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. Nothing on this Blog constitutes investment advice, performance data or any recommendation that any security, portfolio of securities, investment product, transaction or investment strategy is suitable for any specific person. From reading this Blog we cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you, so any opinions or information contained on this Blog are just that – an opinion or information. You should not use this Blog to make financial decisions and we highly recommended you seek professional advice from someone who is authorised to provide investment advice.

TLDR: US Yield Curve is inverted, indicating recession, massive quantitative easing /money printing has plunged the value of the US dollar in real terms due to increased inflation, while interest rate hikes have artificially propped up demand relatively. As the world's reserve currency, the US has control over money printing and refinancing debt, but the increase in US debt raises global economic risks. BRICS nations are considering creating their own reserve currency due to their combined GDP potential by 2030 and getting joined by Saudi. Russia and China have increased their gold reserves, a safe haven asset, as a solid foundation for a new currency. In due time if US asset-debt-inflation bubble pops, it will be the death knell for petrodollar backed US fiat reserve currency hegemony and usher in a new global economy.

The US Treasury Yield Curve is currently inverted, meaning short term interest rates are moving up, closer to (or higher than) long term rates. This unusual occurrence, called a yield curve inversion, has historically been a very reliable indicator of an upcoming economic recession. Since World War II every yield curve inversion has been followed by a recession in the following 6-18 months, and recessions are naturally correlated with decreased stock market returns, unemployment and reduction in GDP and other productivity metrics.

US Money Printing

The US has printed a large amount of money by inflating its M1 money supply, causing a decrease in the value of the US dollar compared to other currencies like the Indian Rupee and the British Pound. The supply of the US dollar has increased, leading to a decrease in its value. However, all other currencies are being impacted more severely due to the simultaneous rise in US interest rates which is offers a better risk adjusted return now compared to say that of a emerging economy like India. Majority of the world debt is denominated in the US dollar, USA has a lot of debt, which is similar to India and China, but being the world's reserve currency has massive benefits.

The US has the ability to print money and refinance its debt, which is not possible for other countries like India and China. Reserve currency is the apex currency, giving US complete control over how much currency they can print and withdraw from the market for example by printing quantitative easing or investing public money into defaulting big banks to prop up the economy. 60% of the world trade happens in the US dollar, so countries like India are required to hold a certain number of US dollars, even if they don't want to take debt in it. Foreign countries hold ~$7.5T worth US treasures as of July 2022. The more the US decides to print money, the more its debt increases, which raises the risk in the global economy. This increase in risk affects emerging economies the most, as they become more vulnerable to financial instability. When the world takes on more debt and the risk of the global economy increases, investors start to search for safe haven currencies to put their money in, which becomes the US dollar. This is why we have seen instances of foreign institutional investors withdrawing money from markets such as India, due to rising global risks from events like the Russia-Ukraine conflict and the COVID-19 situation.

According to a recent study, the reversal of quantitative easing (QE) by central banks has led to a vanishing of liquidity in financial markets. The study, which was presented at the Federal Reserve Bank of Kansas City's Jackson Hole conference in August, shows that the financial sector has become dependent on easy liquidity due to QE, which may make it difficult for central banks to reverse. During QE, central banks buy long-term bonds from the private sector and issue liquid reserves in return. Commercial banks hold these reserves and finance their own asset purchases with short-term demand deposits that represent potent claims on their liquidity. Additionally, to create additional revenue streams, commercial banks offer reserve-backed liquidity insurance to others, such as households, asset managers, and non-financial corporations. Speculators, including pension funds, have also been affected by the low returns on long-term gilts induced by QE. They have increased their risk profiles and taken on more leverage, which has generated margin calls on their derivative positions. In the event of a shock, such as a government-induced scare, the financial sector generates substantial potential claims on liquidity, which can become a big problem if there is a shortage of spare liquidity. The study also finds that, in the case of the United States, QT makes conditions even tighter, as the financial sector does not quickly shrink its claims on liquidity. This makes the system vulnerable to shocks and can cause massive dislocation in financial markets. The onset of the pandemic in March 2020 was a large liquidity shock, which prompted central banks to flood the system with reserves. In conclusion, the longer the duration of QE, the greater the liquidity that financial markets become accustomed to, and the longer it will take for central banks to normalize their balance sheets. Monetary policymakers find themselves in a difficult position as they may need to raise rates to reduce inflation while also supplying liquidity to stabilize government bond markets. The study co-authored by Rahul Chauhan and Sascha Steffens highlights the interdependence between central banks, commercial banks, and financial markets and the importance of monitoring the effects of QE and QT on financial stability.

Western Hypocrisy

Cumulative carbon emissions per capita from 1851-2021(tonnes, CO2), Carbon Brief

The West, specifically US and EU, are considering implementing a carbon border tax. This is being done with the aim of leveling the playing field for their products in the international market, as other countries may have less stringent environmental regulations, leading to cheaper goods being produced. The carbon border tax would be imposed on goods entering the EU or US from countries that do not have the same level of carbon regulations.

This move is being criticized as hypocritical as the developed countries, who are now imposing the tax, have emitted a significant amount of carbon during their own development phase, and are largely responsible for climate change. The imposition of a carbon tax on developing countries, such as India and China, is seen as unfair as they need economic fuel to grow and are still in their developing phase. The carbon border tax is being viewed as a way for the developed countries to maintain their dominance in the international market and prevent companies from moving to countries with less stringent regulations.

‍THE BRICS CURRENCY

The BRICS nations (Brazil, Russia, India, China and South Africa) are considering creating their own reserve currency, the BRICS currency, due to the potential of controlling 50% of the world's GDP by 2030. The challenge of creating a currency through multiple nations is complex and would require a central bank to regulate it. The issue is that each nation would want to exert its own dominance over the currency and their political structures and growth goals are very different.

With a combined population of over 3 billion people, the BRICS countries represent nearly 42% of the world's population. In terms of gross domestic product (GDP), the BRICS nations account for over 23% of the world's total economic output, with China and India alone contributing over half of the group's total GDP. Trade between the BRICS countries has also been on the rise, with their collective trade volume reaching nearly $7 trillion in 2022. The BRICS nations have been working towards increasing economic cooperation and integration, with initiatives such as the BRICS Trade Fair and the New Development Bank, aimed at promoting trade and investment among the member countries.

In recent years, Russia and China have been increasing their gold reserves with the aim of creating a new gold-pegged reserve currency as part of the BRICS nations. The BRICS nations, consisting of Brazil, Russia, India, China, and South Africa, have been considering creating their own reserve currency in light of the potential of controlling 50% of the world's GDP by 2030. According to figures from 2022, Russia's gold reserves had increased by nearly 20%, while China's had increased by over 50%. The increase in gold reserves is significant, as gold is widely considered a safe haven asset and is expected to provide stability in times of economic uncertainty. Gold is widely recognized as a valuable currency, and having a significant amount of gold in reserve provides a solid foundation for a new currency. US fiat currency based on trust is being misused by US to print away their problems by reducing their debt burden in real terms while simultaneously exporting inflation to the entire world. The creation of a new gold-pegged reserve currency could have far-reaching implications for the global financial system, by replacing US hegemony, reducing misuse by printing money, providing stability and reduce the vulnerability to economic and financial shocks, give BRICS nations greater control over their financial futures and provide an alternative to the IMF's Special Drawing Rights. This currency would be a basket consisting of the Chinese Renminbi, Russian Ruble, Indian Rupee, Brazilian Real, and South African Rand, thus expected to be more stable and semi-decentralized. The introduction of a currency backed by gold has not been seen in half a century and if the BRICS nations are successful, it could become the most valuable currency in the world.

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SAUDI and China Angle

China is motivated to end the dominance of the US dollar as the world's reserve currency due to the two major advantages it gives the United States. Firstly, the US has the "exorbitant privilege" which allows it to spend more than it earns due to its status as the issuer of the world's reserve currency. Secondly, the US can harm its enemies by excluding them from the dollar-based international financial system, which restricts their ability to buy crucial imports and get new loans. China has seen this play out with Russia, where US banks were forced to stop doing business with Russian banks, and a large chunk of Russian foreign currency reserves were frozen. These factors have motivated China to come up with a plan to challenge the dominance of the US dollar.

In order to make the Chinese currency, Renminbi, more attractive to traders and countries outside of China, there are three main steps that need to be taken: improving spendability, investability and liquidity of the currency.

Spendability is how easily the currency can be used for transactions and purchases internationally. Currently, the US dollar is the most widely used currency for international transactions, while the Renminbi is only the eighth most traded currency. To increase the spendability of the Renminbi, China has promised full Renminbi settlement in oil and gas trade, which would make the currency more widely accepted for payments. Additionally, China has also promised to deepen digital currency cooperation and advance the multiple central bank digital currency project, which could make it easier for people to use Renminbi for international transactions.

Investability is attractive it is for people outside of China to save their wealth in Renminbi assets. Currently, European banks and brokers do not offer access to financial markets in mainland China, making it difficult for people to invest in Renminbi assets. However, in recent years, big banks in places like London and New York have started offering Renminbi accounts, and big investors have been pouring money into China. However, China still heavily restricts access to its financial markets for foreigners, which makes it difficult for big global companies and countries like Saudi Arabia to invest in Renminbi assets.

Liquidity is easily a currency can be obtained and traded in the market. Currently, the US dollar is the easiest currency to obtain and trade in foreign exchange markets, while the Renminbi is not as widely available. To increase the liquidity of the Renminbi, China will need to make it easier for foreigners to obtain the currency and trade it in the market.

The recent prospect of Saudi Arabia joining BRICS is an interesting one, as it could bring significant benefits to the group. With its large oil reserves and strong economy, Saudi Arabia could play a crucial role in supporting the economic growth of BRICS and strengthening the group's position in the global economy. Additionally, the addition of Saudi Arabia could provide a boost to the BRICS currency, as the country has expressed interest in using the currency for its international trade and investments. Saudi Arabia selling to the United States gives them a $7T dollar advantage due to petrodollar recycling. Under a currency exchange agreement as part of BRICS however, BRICS countries, particularly India and China who are the largest oil consumers, would no longer have to buy oil in dollars. This shift away from the dollar would be a significant blow to the American economy, as bank interest rates would skyrocket.

China alone owns one trillion dollars in U.S Treasuries, and without the need to buy oil in dollars, they may choose to sell those bonds, causing a significant dent in the American economy. In contrast, China has already developed a alternative to the current SWIFT international payment network, known as the M-Bridge prototype, which is essentially an alternative to the Swift system for making international transactions using a Central Bank digital currency.

USA Inflation and stock market:

‍‍While SP500 Total Returns has grown 58% in the last 5 years, adjusted for the massive money printing, it has given a real return of just 4%. Almost losing 7% of money to inflation per year or 0.59% per month. At this rate, in 10 years over 50% of money has evaporated.

The Federal Reserve has two mandates: to minimize unemployment and control inflation. Currently, inflation is at an extremely high rate of over 8 percent, which is the highest seen in decades. The high inflation is a result of various factors including supply chain issues due to COVID-19, pent-up demand from the pandemic, $5Teconomic stimulus, the Russian-Ukraine war, and historically low interest rates.

The main tool the Fed has to combat inflation is raising the federal funds rate, which is the rate at which banks and financial institutions lend to each other. When this rate increases, it becomes more expensive for consumers and businesses to borrow, resulting in less spending and potentially lower prices to attract customers. This decrease in demand and supply can eventually lead to a decrease in inflation. If inflation goes up, value of currency goes down which translates into people and businesses spending money as soon as possible which increases the demand over supply and thus causes more inflation and the cycle continue which if not controlled can lead to stagflation, with high inflation and unemployment with low economic growth or even hyperinflation.

However, many believe that the Fed's plan to raise interest rates until inflation comes down, as stated by its chair Jerome Powell, will lead to a recession. The hawkish stance by the Fed has already resulted in investors selling riskier assets, leading to a bearish cloud over the markets. A recession is usually defined as two consecutive quarters of declining GDP growth. Additionally, according to a study done by larry summers and alex domash the combination of greater than five percent inflation and unemployment of less than four percent makes a recession. The first quarter of 2022 saw a 1.5 percent decline and the second quarter saw a 0.9% along with employment rates of 3.5% suggesting USA has begun its recession.

Effect on India

Recession in US along with rate hikes is a big deal for the Indian economy as this has a direct impact on several inflows.

1. Currency carry trades. This affect the value of our currency which then takes a toll on our Imports because Imports become costlier profit margins become thinner in every import dependent industry as a result the cost of the products go up eventually causing a ripple effect in the economy. The currency carry trade is a trading strategy in which an investor borrows money in a low-interest rate currency and invests it in a high-interest rate currency, with the aim of profiting from the difference between the interest rates (known as the "carry"). This strategy can be risky, as changes in currency exchange rates can wipe out the potential profits from the interest rate differential. America hiking the rates means money flows out from India to America and additionally increasing demand for dollars against INR which depreciates the currency further.

2. IT industry is crucial for India, contributing 8% to the country's GDP and employing 5 million people. Indian IT companies largely rely on the US and Europe for their revenue, with 86% coming from these regions in FY22. In the event of a recession in the US, the Indian IT industry may be impacted as expansion by foreign companies to utilize more IT services from India will stop as they halt their expansion plans in their operating markets. The Indian IT industry may face a growth slowdown, but will thankfully not completely shut down. Infosys, for example, saw an increase in revenue during COVID-19 but a drop in operating margins from 25% in 2015 to 21% in 2020, due to the high attrition rate in the industry. While a recession may affect the salaries of IT professionals and operating margins, the importance of software in business will ensure the industry continues to operate.

3. Merchandise sales and garment sector are expected to experience a significant impact due to the presence of large clients in Europe and the US. The US is the largest export destination for India, accounting for 16-18% of total exports. A recession in the US would directly result in a decrease in exports from India.

4. another significant challenge that the Indian markets will face due to a potential US recession is a decrease in start-up funding and an increase in layoffs. Investors are now placing a stronger emphasis on profitability for start-ups, and companies that are unable to achieve this are either cutting jobs or going bankrupt.

It's not all bad news during a recession. One potential positive impact is a decrease in oil prices. If oil prices fall and the government takes advantage of the situation, fuel costs could go down, acting as a counterbalance to inflation in the country due to reduced transportation and goods costs, especially when India spends ~$80B annually on oil imports. This however in the short term seems to be unlikely as Saudi has leveraged the Russian oil supply cut to reduce its own supply too thus inflating the prices of oil in an attempt to profit as much as possible something which they haven’t been able to do since 2015 until now. Additionally, commodity prices are expected to drop further. If the depreciation of the rupee is kept under control which the RBI has already taken steps to by increasing Indian interest rates and selling forex dollars in exchange for rupees and there is no further impact on prices, India could benefit from low-cost imports.

Sources:

https://youtu.be/HofmLFn6MTo

https://youtu.be/iIxKhF6ZLOs

https://youtu.be/rfZ7u-ecfEg

https://youtu.be/owWUyOm7SBE

https://wap.business-standard.com/article-amp/economy-policy/statsguru-from-india-to-us-six-charts-show-rising-global-inflation-122041700808_1.html

https://youtu.be/aAYziRy3kJ8

https://youtu.be/49iLl-V4xos

https://www.stern.nyu.edu/experience-stern/faculty-research/where-has-all-the-liquidity-gone

https://www.sascha-steffen.de/updates/why-shrinking-central-bank-balance-sheets-might-be-an-uphill-task

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. Nothing on this Blog constitutes investment advice, performance data or any recommendation that any security, portfolio of securities, investment product, transaction or investment strategy is suitable for any specific person. From reading this Blog we cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you, so any opinions or information contained on this Blog are just that – an opinion or information. You should not use this Blog to make financial decisions and we highly recommended you seek professional advice from someone who is authorised to provide investment advice.

The Digital Public Goods Alliance aims to promote digital public goods (open-source software, data, AI models, standards, content) for attaining sustainable development goals in low- and middle-income countries. These goods aim to reduce monopolies, foster innovation, and address the digital divide by following privacy laws and best practices while promoting the SDGs. This is done in collaboration of government and IT industry. The growth of India's IT services sector is rapid, with over 90,000 startups contributing to the $40.7B raised in 2022 itself. These startups drive innovation and challenge established players to keep up, leading to a dual boost in innovation. This article will discuss some of the key DPGs of India that is transforming the Indian economy. Previously fragmented, it has undergone integration over the past decade through the expansion of highway networks, tripling of local airline traffic, implementation of GST, and advancing towards a digital economy by incorporating advancements like Aadhaar (2010), UPI (2016), and ONDC (2022). These advancements will provide India with a worldwide edge in the flow of money and goods.

Unlike other developed economies with exponentially higher ad spends per capita, in India advertising dollars cannot subsidize the creation of digital platforms which is why India needed to build its own microtransactions digital platform. UPI, with the help of Aadhaar identity, aadhar KYC for banks, affordable internet, digilocker and aadhar e-sign enables a high-volume, paperless, cashless, digitally verified zero-fee economy. Tax collection has also improved, highest 11.7% Tax to GDP in the last decade, more money to finance government spending. Additionally, there has been a rapid improvement in bringing capital to markets, be it through IPO applications or SIP autopay mandates all connected to UPI and bolstered by higher financialization of savings. On the logistics front, FastTag, eWayBill and GST have cut waiting times from days to minutes for vehicles with the ease of keeping the same tag no matter what state you are in and automatic debit from your connected accounts. The end result is all these saving millions of tonnes of CO2 emissions, improvement of revenue collection at tolls by reducing leakage and improving monetizability.

Over 1.31B of 1.41B Indians have enrolled in Aadhaar and linked their IDs to their bank accounts, establishing it as the globally, the largest and most successful national registry project, enabling the easy facilitation of targeted, direct welfare programs. Aadhar enabled state and union governments to roll out relief worth over Rs. 26.3Trillion in FY21-22 during pandemic. JAM (JanDhan-Aadhar-Mobile) has revolutionized the delivery of government benefits by reducing leakages to intermediaries and duplicate claims and using Direct Benefit Transfers to transfer financial benefits directly to the beneficiaries' bank accounts. Over 90 million Indian households are eligible for DBT and by December 2022, deposits under Jan Dhan exceeded Rs. 1.8Trillion, with 478 million accounts opened, 265 million of which were for women.

The mobile phone, being the final part of the "JAM trinity", connects Aadhaar holders with their Jan Dhan bank accounts. The widespread availability of cheap 4G access through Jio and affordable smartphones led to a surge in mobile data usage (now the highest in the world, grown 40x in last decade), resulting in a system that minimizes the potential for fraud and leakages, while promoting financial growth. This paved the way for the launch of UPI, enabling real-time payments through any bank account registered on the UPI app using just a phone number or QR code, improving the speed of money circulation, which in turn could lead to a more rapidly growing economy. As of FY22 as per NPCI and RBI data, around 88% of all transactions by value in India were through digital methods, most popular being NEFT( 55%) and UPI (16%). By volume, UPI transactions account for 40% of all digital transactions.

The implementation of a unified Goods and Services Tax (GST) in 2017 has led to increased enforceability and compliance, boosting tax collections. The removal of fragmented taxation across states and trade levels has led to an increase in both direct and indirect taxes as a percentage of GDP.

Efforts to tackle tax evasion have led to a shift by Indian households from physical savings to financial savings, resulting in incremental financial savings of $300 billion per year in the past five years. This coupled with demonetization has also shrunk the informal unorganized sector from 52% in to less than 20% by FY18. This has significantly lowered the cost of capital for companies with good financial standing and responsible allocation of funds.

India has huge demand for credit and now bigger supply due to increasing financialization of savings (14.8% in FY22 v/s 7.7% in FY18), facilitated by DPGs to better analyse and reduce risk, price risk and collected digital cash flow. Volume, velocity, diversity of credit expected to explode. Currently small ticket loans are increasing due to informational collateral instead of physical collateral. The Indian banking sector faced severe trouble by 2015, due to sour loans to power and infrastructure. It was revived in the past 6 years through various measures, including the RBI's Asset Quality Review (2015), the implementation of Insolvency & Bankruptcy Code (2016), and merging of struggling public sector banks with strong capital adequacy. These actions effectively reduced stress assets and strengthened the sector.

‍ONDC (Open Networked Digital Commerce) aims to democratize the ecommerce industry by providing greater control to consumers and increasing visibility for smaller vendors. ONDC functions as an interoperable facilitator of trade, enabling consumers to choose from various sellers, payment methods, delivery agents, etc. The system should increase competition and efficiency, leading to a boost in economic growth. The ecommerce market is currently dominated by a few large platforms that have significant control over which sellers can list products and at what price. This limits the ability of smaller producers to reach customers through these platforms. Additionally, these platforms offer a bundled experience, where each step from payment to delivery is controlled by the platform, making it difficult for consumers to purchase items from smaller businesses directly. This also results in small businesses becoming dependent on the platform, as leaving it would result in loss of customers and ratings. ONDC aims to address these challenges by providing a more inclusive and transparent ecommerce ecosystem which should boost economic growth.

1. Why Would Ecommerce Giants Agree to ONDC Despite potential competition? ONDC enables trade by providing increased visibility for sellers to access larger markets, leading to market expansion instead of substitution. The giants can continue their own platforms while also joining ONDC, offering more options to buyers and increased visibility for sellers.

2. Who Will Assume Responsibility for Issues in ONDC's Disaggregated System? ONDC records data at each step of the process to track what has been dispatched, received and its condition. The right agent in the system is likely to assume liability for the product, making it easily trackable.

3. Can ONDC Protect Buyers' and Sellers' Information While Maximizing Benefits? Orders placed on ONDC are considered digitally signed micro-contracts, ensuring fulfillment of commitments. Additionally, the buyer and seller catalogs are independent at all times, preventing misuse of data.

The digital network of India built on Aadhar, Jan Dhan, UPI and cheap mobile data and phone access, provides a strong foundation for ONDC to succeed which is why other countries have failed to create anything similar yet due to lack of the basic foundation that JAM has built. ONDC benefits both SMEs and customers and this step-by-step development of India's digital economy will be a massive competitive edge in the coming decade. Ecommerce by ONDC will bring small retailers to focus. Improves digitization of payments, inventory, discovery and logistics. This will be bolstered by DPGs Bhashini which uses AI to solve last mile problems for users in 22+ languages.

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Investment Implications

Over the past decade, well-managed companies have leveraged structural changes in the economy to improve their business performance. These improvements have increased their asset turnover, operating efficiency, and working capital cycles, resulting in higher free cash flow and the ability to scale the business 4-5x. In the 10-year period ending March 2012, the Nifty index added $440B in market cap, with 80% coming from 17 companies and a median Total Shareholder Return (TSR) CAGR of 26%. The top 20 FCFE companies accounted for only 23% of India's FCFE. In the next decade ending March 2022, the Nifty added $1.4T in market cap, with 80% coming from 20 companies, a median TSR CAGR of 18%, and the top 20 FCFE companies accounting for 51% of India's FCFE. What should be noted is that the type of concentrated wealth, while PAT of the top 20 firms remained stable, FCFE doubled as a percentage of total.

Why is this the case?

1. Efficient companies leverage networked economies better: Efficient companies with strong nationwide distribution systems have gained an advantage over regional and local players due to the rise of affordable and user-friendly enterprise technology such as mobile, SaaS, and cloud, leading to increased profit margins, reduced working capital cycles, and improved asset turnover when effectively implemented.

2. Investing in technology leads to increasing returns to scale.

Increasing returns refers to the tendency for returns to increase as output increases with minimal additional inputs. This modern economy shift from diminishing returns is due to the economy moving from resource-based bulk processing to knowledge-based design and reproduction. The nature of goods produced has changed from bulk-produced and process-driven to technology-driven and customized, creating a positive feedback loop in the economy. Algorithms once developed can be applied to numerous other functions with slight tweaks, making the marginal cost of production redundant. An example of increasing returns is Microsoft's Windows operating system, which expanded its offerings at marginal cost and leveraged network effects to dominate the operating system industry.

3. Profit growth is less tied to traditional capital expenditures

In the past 40 years, corporate investments have shifted from tangible to intangible assets which affects businesses:x

• Scalability: once developed, intangibles can be easily scaled to any level

• Synergies: multiple intangible assets can collectively produce higher returns.

• Sunk costs: costs tied to intangibles cannot be recovered

• Spillovers: benefits of intangibles investments are often reaped by others

These factors are crucial in becoming a consistent compounder as a company can scale its intangible assets (e.g proprietary database), extract spillovers (e.g. third party platform like SAP), and create synergies between its intangible investments (unique database connected to SAP with big data), potentially dominating its industry in domestic and international markets.

Growth of Startups, FDI and GDP

GDP has grown at 7.1% CAGR and FDI inflows have grown at ~9% CAGR, from 2011 to 2022, making it one of the fastest growing economies in the world. Services sector accounts for over 55% of the GDP, and the industrial sector, which accounts for nearly 30%. The services sector has been growing at a CAGR of around 8% and the industrial sector at a CAGR of 7%. The major industries contributing to the growth of the services sector include the IT and ITES, banking and financial services, and tourism. Meanwhile, the key industries driving the growth of the industrial sector are pharmaceuticals, automobile, and chemicals. The FDI inflows into these sectors have been particularly strong, with the IT and ITES sector attracting the highest FDI inflows at a CAGR of over 10%.

The startup industry in India has been thriving over the last decade, growing at a much faster rate than countries such as the United States and China, with growth rate of ~17% CAGR in the number of start-ups, making it one of the largest startup ecosystems in the world and ranking 2^nd globally in terms of number of unicorns as of 2022. In the last 10 years, these industries have raised a total of $70 billion in funding. With a large pool of talented and ambitious entrepreneurs, the country is well on its way to becoming the foremost start-up hub. This growth in the start-up sector has not only contributed to the country's GDP but also helped to attract a lot of FDI. With the government's continued efforts to create a favourable business environment and attract foreign investment, it is expected that India's economy will continue to grow in the coming years.

The future of Indian connectivity

The currently in progress infrastructure connectivity plan, GATI Shakti ’s main objective is to build a robust, secure digital infrastructure to integrate 16 of the Government of India's key ministries and departments, including the Railways and Roadways. This will streamline information flow and accelerate project clearance processes through better coordination among the ministries. This is also expected to generate employment for millions and meet three key objectives: seamless multimodal connectivity for easy movement of goods and people, optimized resource usage and capacity creation, and resolution of disjointed planning, standardization, and clearance issues. Key components of the plan include the expansion of high-speed internet connectivity connecting all gram panchayats, development of digital infrastructure, establishment of data centers and cloud computing services, and the promotion of electronic transactions. To ensure the security of digital transactions, the plan calls for the implementation of cybersecurity measures, including encryption and authentication. Additionally, the plan aims to provide digital literacy and skilling programs to help citizens take advantage of the digital economy.

UPI 2.0 is expected to enable data-less money transfer just with SMS eliminating the need for internet and smartphones and Jan Dhan 2.0 is expected to focus on digital literacy, better risk analysis for improving credit access especially to women, additional banking facilities and incentivizing savings. The democratization of credit through an Account Aggregation Framework, combined with simplifying commerce through ONDC and logistics transformation, will bring about a revolution in ecommerce and banking in India, particularly for marginalized communities. Instead of creating fullstack solutions to sell digital products, India is making fullstack solutions to sell physical products in a digitized economy, connecting around 1.4 billion people.

A decade of these economic changes has produced a group of efficiently-run, technologically advanced Indian firms listed on stock markets that invest greatly in intangible assets such as R&D, networks, training, branding, and databases and contribute to the growth story that is India. The digital economy in India has tremendous potential for growth and development. With a large and young English-speaking population, increasing internet and smartphone penetration, and supportive government policies, India is well positioned to become a leader in the digital space. With continued investments in technology, education and training, and innovation, India is unleashing the full potential of its digital economy, creating new opportunities and improving the lives of its citizens

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https://youtu.be/py0cfqlhTp8

https://youtu.be/YygkS-vosNI

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. Nothing on this Blog constitutes investment advice, performance data or any recommendation that any security, portfolio of securities, investment product, transaction or investment strategy is suitable for any specific person. From reading this Blog we cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you, so any opinions or information contained on this Blog are just that – an opinion or information. You should not use this Blog to make financial decisions and we highly recommended you seek professional advice from someone who is authorised to provide investment advice.

Cryptocurrencies are digital currencies that use cryptography to secure transactions and control the creation of new units of currency. They can be sent directly from one party to another without the need of any intermediary, such as a bank or government. Investing in cryptocurrencies is not for the faint-hearted. It is a volatile asset class where you can make or lose money quickly. Due to the increasing number of cryptocurrencies and exchanges, it is important to do your research before you invest in any cryptocurrency.

WorldBank, Crypto.com

Cryptocurrency adoption is growing around the world. Triple-A a leading crypto payments processor estimates as of 2022, crypto ownership rate is at an average of 4.2%, with over 320 million crypto users worldwide and predicts the cryptocurrency market to compound at 56.4% annually from 2019 to 2025.

Things to consider even before you decide to invest in crypto:

1. Portfolio Diversification & Allocation

One thing you should think about before getting into cryptocurrencies is if your portfolio already allows for investment in it? Different assets suit different people, so it's worth thinking about this beforehand. Your crypto investment is not a stand-alone investment, but an extension of your overall investment portfolio. While it’s standard practice to decide beforehand the amount you’re willing to put into an investment of regular instruments like stocks, bonds and real estate due to an abundance of historical data, crypto is different. On average stocks return ~6% more than bonds, but this information took us close to 100 years of studying the average returns on stocks and bonds. Crypto being new, we lack such concrete long-term data. If your portfolio allocation does not suit a particular cryptocurrency, then there are two ways that you can go about this:

1) Adjust your portfolio allocation so that it suits the new crypto investment

2) Invest in crypto trackers which will allow you to invest in a basket of cryptocurrencies and still maintain your current portfolio allocation.

Examples of diversification, OKEX, CoinTelegraph

Additionally, the general rule for investors is not to invest more than 5% of their total portfolio in a single asset. Investing in crypto is a good way to diversify your investments, but you will still need to diversify even within crypto. Invest in different cryptos and avoid putting all your eggs in one basket.

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2. Risk associated with crypto investment v/s other traditional assets

1. Volatility: A cursory glance on any cryptocurrency price chart for the last few years is enough to drive home the fact that volatility is easily one the biggest risk even for the coins with the highest market caps and adoption rates.

2. Regulatory uncertainties: Whether they are legal or illegal where you live. In some countries, trading or owning certain types of cryptocurrencies may be illegal and could result in fines, jail time or both. Exchanges around the world have to constantly be on their tiptoes. For example, Crypto currencies were banned in India for 2 years from 2018 to 2020 and in China Cryptocurrencies have been banned since 2019.

3. Insurance: Almost no government backed protection for crypto investors similar to a traditional FDIC insurance that comes standard with fiat money in most developed for customer deposits in registered banks. However not all hope is lost since you will have to resort to private insurance products. Breach Insurance offers crypto-insurance as a product called Crypto Shield, Coinbase also provides theft protection directly on its platform as an integrated product, Coincover insures against technology failures.

4. Crypto scams & Hackers: Hackers have already stolen ~2 billion USD worth crypto just in 2022 and scams like SquidGameCoin, Fake Ukraine donation to highly leveraged pyramid schemes that promise too good to be true returns on deposits, the landscape for crypto investment is unfortunately ripe to rip off people who don’t enter with sufficient research, security and privacy. Be wary of fake ICOs, coins, and tokens. It's easy for scammers to create a lookalike website to scam users. To avoid falling for such scams always do research on the company and its official social media channels before investing any money in an ICO. You should never invest in cryptocurrencies or ICOs based on social media hype.

IMF

Objectively considering these risks will help you in more ways than you’re away of. It will help you in choosing an exchange to invest with, the coins you buy, and then the ones you avoid.

3. Long term game

Bitcoin took 10 years to $50,000 that too in a very volatile manner. For any other token this will be the case and only the ones that research the most and are most dynamic in their investment decision with an ability to look beyond the curve will be making long term exponential gains. A good way to achieve this is to keep in mind the aforementioned guidelines and broad bull-bear market cycles as you look for projects to steadily accumulate over time. These projects should have a real-world use case, a welcoming community, and a committed development staff. A nice example is Pumpkittens' GameFi project on Fantom. The project has a tiny crew and no investors or VC support. But when the community began to participate after seeing the possibilities of the innovative ideas they presented. And as a result, it has become one of Fantom's greatest ventures. Thus, having a small team isn't always a bad thing; you just need to consider its long-term potential.

4. Alternate ways to gain exposure to crypto, passively:

Maybe after your research you have come to the conclusion that your portfolio is better suited to handle exposure to cryptocurrencies passively. Here are some ways to do the same:

1. Buy shares of publicly traded crypto companies with big exposure to crypto directly. Some common ideas inclue – Coinbase, operates a crypto exchange platform, PayPal, also involved in crypto investing and transactions, Microstrategy, huge exposure to cryptocurrencies as part of its investment portfolio.

2. Buy shares of companies that make crypto-related hardware, such as Nvidia and AMD.

3. Invest in crypto ETFs or derivatives. Crypto ETFs track a single cryptocurrency or a basket of different digital tokens and currencies. They have low cost of ownership, are diversified, and saves you the stress of having to picking tokens to invest in.

Crypto ETF Benefits and limitations, CentrePoint Securities

With decades of development ahead of them, cryptocurrencies and the widespread use of blockchain technology are still in their infancy. Therefore, to give yourself the best chance of long-term success, remember to unwind, reduce your FOMO, and adopt a more methodical approach to investing in the cryptocurrency market.

This is the second part in a crypto series, focused on crypto investment management. There's a part 1 that deals with crypto research and part 3 that discusses the concept of asset tokenization.

‍‍Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. Nothing on this Blog constitutes investment advice, performance data or any recommendation that any security, portfolio of securities, investment product, transaction or investment strategy is suitable for any specific person. From reading this Blog we cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you, so any opinions or information contained on this Blog are just that – an opinion or information. You should not use this Blog to make financial decisions and we highly recommended you seek professional advice from someone who is authorised to provide investment advice.

How to Perform Crypto Research!

The crypto industry is considerably more dynamic than other asset classes in a lot of ways and can thus feel very overwhelming even to seasoned investors with experience in investing in crypto. Having an investment research checklist ensures that you don’t overlook any telling factors that might affect your gains or even wipe out your entire portfolio.

Similar to investment in other asset classes, crypto too has its own intricacies and based on my research, this is the most comprehensive diligence checklist that I would personally use.

This is the first part in a crypto series focused on crypto selection and research. There's a part 2 that deals with crypto investment management and part 3 that discusses the concept of asset tokenization.

1. The Team

For crypto, you need to kind of put your venture capital hat on rather than always thinking like a trader even if you are in it for the short term because of how fast the crypto market can move in the exact opposite direction. Venture Capital investors focus a lot on the founding team because so much changes in a business when you just build out a company and you really need to have a strong team that's really able to pivot execute on delivering great products and over a long period of time really create an outstanding company. Similarly, crypto as part of the landscape also has to have a good founding team to ensure the base product actually can serve the consumer for as long as possible. Some good things to keep a note of for researching the team is as follows:

Founding team should be public and have a proper online presence beyond just text on a website. This can be appearances in podcasts, tech conferences, reddit forums, YouTube and news interviews anything not just to learn about them but also about the project. Being public doesn’t necessarily mean a winning team but its much better than unknown founders.

The founding team members should also be vetted on LinkedIn to see what kind of a background the top-level management or even middle level engineers have and what kind of jobs they are hiring for currently if any. If a few members have really good brand names for schools or work ex, this demonstrates that people were willing to leave their high paying and secure jobs to join a new crypto project which is considerably lot riskier.

2. What It Does

Specifically try to understand what problem does the project solve using the company's resources like their website, white paper, blogs. Usually founders and key employees on podcasts and youtube interviews will will explain their projects in a lot more digestible manner than a white paper so you can start with that. Beyond this, social media presence of the project is also important to analyze.

Types of crypto

This includes medium articles reddit posts and twitter threads and there's a lot of really great information out there from retail investors and also institutional investors you kind of have to look through all of the noise in order to get the best stuff but still.

If you're confused about something and want a simple explanation, google “eli5 + “ and then your term so something like eli five tera reddit and then articles will come out like you see here explaining what the project is like as if you're a five-year-old (eli5 = explain like i'm five).

3. Exchanges

Being listed on top exchanges isn't necessarily an endorsement, but it does show it's a relatively well-established project. Newer crypto investors may prefer to stick to cryptos they can buy on a centralized crypto exchange. More experienced or adventurous investors may decide to use a decentralized exchange to access less-common cryptocurrencies. Whichever route you go, make sure you'll be able to buy a crypto on your platform of choice before you spend hours researching it. Things to keep in mind:

a. Liquidity: Ease at which an asset can be bought or sold. If there is a lot of liquidity, then there will always be a buyer or seller waiting on the other side of your order request.

b. Security. When your money is on an exchange, you are trusting them to hold your funds, so you better hope that their security is up to par. Exchanges are constantly under attack.

c. Fees: Can affect your margins a lot

4. Adoption

No matter how much retail or institutional investors pump up the prices for crypto the only thing that will truly create sustainable and really drive crypto's growth in the long run is the adoption of projects.

High Github activity is a good sign to do a basic test for authenticity

Things to look for include:

1. Number of applications built on the protocol which the project usually keeps track of on its website

2. % staked which can be found on stakingrewards.com

3. Total value locked which can be found on d5lama.com

4. Number of wallet users which most projects have a dashboard for or you can google. For e.g. “tera wallet users”

5. Github contributions which you can find if you click this insights button here

6. Social media figures: twitter, telegram, discord especially to compare against other projects. Additional news aggregators for crypto news are: CryptoPanic, FAWS, Crypto Research Report

7. Find out if it is active- If a project is not active, it could have been abandoned or could be a crypto scam. Things to look out for this are:

8. Social media, website activity: Is the website up to date? Does the project post regularly on social media? whether it's on Reddit, Telegram, Discord, or elsewhere.

9. Developer activity: More the developer activity on github or wherever the project is hosted, the better

10. Trading volume: High trading volume is a sign of greater liquidity and more stability

5. Competitive Landscape

Because crypto projects move so fast you always want to make sure that you're investing into the best projects because those are really the ones that are going to accrue value. Firstly, figure out which category the crypto project falls in

Most common categories of crypto

Then find the top 3-5 players in the space, one of them hopefully which is the one that you're doing a deep dive analysis on. The most popular names will kind of pop up frequently in the articles you read read twitter threads you look at or the interviews you listen to. Some of these as of this year are:

50 most influential crypto companies/ projects in 2022, CBInsights

6. Tokenomics

This is study of the factors that impact the demand and supply of tokens for a crypto project. Some important things to research about the Tokenomics of the project are:

1. Whether or not the token is inflationary or deflationary and also to what extent. E.g. Bitcoin is inflationary but the rate at which the supply is inflating is decreasing eventually to the point of zero. But Cosmos has a high and more stable supply side inflation rate that encourages buyers to stake.

2. Token allocation for the initial release: When the project first launched, this can really tell you how the supply may be affected in the future. If for example most of the tokens have been sold to early investors then that could mean they'll be ready to sell whenever their lock-up expires and this is where a project like solana doesn't look too good. Ethereum was mostly sold to the public which means that there probably won't be much selling pressure from early investors anymore since ethereum has been around for so long.

3. Actual utility makes tokens more valuable while other projects with bad token design make tokens relatively unuseful and lower long-term value

4. Circulating v/s fully diluted supply & Circulating v/s fully diluted market cap: circulating simply refers to the amount that's publicly available to be traded while diluted includes the supply that is eventually going to be released and added to a project supply which creates downward selling pressure. And even for the circulating supply, if a small group of people hold a big percentage of the tokens, or there's no limit on how many can be minted, if a few whales control most of the coins, they will have an outsized influence on the price. If the project plans to create millions more coins, it may dilute the market and cause yours to devalue.

5. Future plans - tokenomics can change if the community votes to do so and this can be a catalyst for a price increase for example tera passed a proposal that resulted in the burning of about 90 million lunar tokens a few months ago which decreased the supply by 9% making the price skyrocket. To view upcoming events at a quick glance, use tools like CoinMarketCal and Coindar.

Ownership Tokenomics for some common cryptos

7. Risks

1. Team may not have a strong background

2. Adoption metrics like total value locked may be shrinking

3. Over-reliance on one project that's carrying the entire protocol

4. New competitor with better tech may come along

5. Poor tokenomics may indicate that a lot of supply will flood the markets soon

One of the best ways to figure out what the risks are is really just looking at reddit and twitter because honestly there's a ton of people who love to hate on projects and if you can filter through the noise, then you can actually consider which ones are bringing up legitimate concerns and better understand what the risks are once you invest into a project. The project's discord which usually has an FAQ channel which provides links to all of the most important blog posts and articles and white papers and everything you really need to know and also feel free to reach out to a bunch of people in the discord as well because usually people are more than happy to answer questions. Even search from that history in that discord because your question may have already been asked. Risk analysis can save you a lot of time and money.

8. Funding

Looking up funding rounds and the venture capitals which back the protocol is crucial because if they run out of money, every other factor will not matter. So, you need to be sure that they have capital available to them for the next few months/years till the adoption increases to a sustainably profitable level.

Global Blockchain funding surges 713% YoY to reach $25.2 billion, CB Insights

This is the first part in a crypto series focused on crypto selection and research. There's a part 2 that deals with crypto investment management and part 3 that discusses the concept of asset tokenization.

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. Nothing on this Blog constitutes investment advice, performance data or any recommendation that any security, portfolio of securities, investment product, transaction or investment strategy is suitable for any specific person. From reading this Blog we cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you, so any opinions or information contained on this Blog are just that – an opinion or information. You should not use this Blog to make financial decisions and we highly recommended you seek professional advice from someone who is authorised to provide investment advice.

Coronavirus disease (COVID-19) is an infectious disease first identified in December 2019 in Wuhan, Hubei, China on 17 November 2019, and has resulted in an ongoing pandemic. Since then it’s spread has resulted in global stock-price volatility, decreases in nominal interest rates, and likely contractions of real economic activities due to uncertainty about how it will affect the economy and for how long. For the current short-term trend, it has translated into extreme volatility in the financial markets and aligns with previous market studies showing economic uncertainty can increase volatility in financial market returns. (Dr. Manish Sharma, 2020) (Bowes, 2018)

Today’s hyper-globalized economies mean that even if India didn’t become the 3rd largest hotspot for confirmed coronavirus cases, it’d still be severely affected by other epidemic struck countries with which it has strong trade relationships with.

ANZ Research economists said ~14 % of India’s imports come from China, making it the nation’s biggest import partner. Indian imports electrical machinery, cell phones, heavy machinery, telecom and pharma ingredients, fertilizer, food, and textiles, etc. from China majorly due to cheap economies of scale. India imported $62.4 billion worth goods from China during April 19’ to February 20’ period. While China accounted for just 5.1 percent of India’s total exports in FY- 2019, on importing chemicals and fuels from India. (Fensom, 2020)

According to Nikkei, as of February 2020 data, telecoms sector is the most financially at risk, with an estimated $30 billion worth of bad loans, followed by steel and infrastructure (~$15 billion each), energy ($12 billion), and textiles (around $10 billion). Nonperforming loans accounted for 8.9% of overall bank lending in India last year. The ratio has risen more than 5 percentage points in five years – the largest increase among the Group of 20 major economies, according to the International Monetary Fund. (Moyuru Baba, 2020)

Figure 1

Figure 2

As with similar global economies around the world, COVID-19 poses a grave uncertainty about India’s economy in both short and long term.

Data Analysis

History of major pandemics:

1918 saw the rise in cases of The Spanish Flu caused by the H1N1 influenza A virus, affecting around 500 million people around the globe and killing an estimated 20 million people more than the death toll of world war 1, after starting in small pockets in Europe, America and Asia. Prolonged quarantine measures and lack of business both domestic and internationally lead to an estimated global economic loss of at least 3 trillion USD. Accurate measures of economic losses and deaths is almost impossible to procure due to lack of accurate enough data entry. After a full year it eventually vanished as the infected either died or developed immunity.

1957 saw the rise in cases of The Asian Flu caused by the H2N2 influenza A virus, originated in Guizhou, China that killed more than a million people worldwide. This affected the global economy negatively by around 2%.

1968 saw the rise in cases of a similar pandemic, The Hongkong Flu caused by the H3N2 influenza A virus, originated in China that killed more than four million people worldwide. This affected the global GDP negatively by a loss of $14.8 billion USD.

2002 saw the rise in cases of SARS which again originated from Foshan-Guangdong, China with only 916 deaths via respiratory system breakdown but caused a massive drop to the global economy to the tune of $33 billion USD.

2009 saw the rise in cases of H1N1 Swine Flu originating from Mexico, which led to a 1.5% loss to the global economy and a loss of 284,00 human lives.

2013 saw the rise in cases of Ebola which originated from Guinea, West Africa resulted in a loss of $2.2 billion to the global economy and more than 11,00 deaths till 2015.

2020 has been ravaged by the current SARS-COV2 Covid-19 pandemic and is estimated to make major economies loose 2.4 to 3.5 % of their GDP i.e. at least a whopping $76.69 billion USD

Since the epicenter of this pandemic is China, how is it affecting China?

The major sources of trade of a country are its imports and exports. China is the 3rd largest partner contributing in the export ($17 billion, 5% total export) and import trade of India. Any undesirable influence on the Chinese industry will have drastic effects on the Indian economy. China is the market leader in trade, exporting worth $2,216 billion followed by USA with $ 1,553 billion and Germany with $ 1,434 billion as of January, 2019. And yet with COVID-19, they managed to keep trade surplus for July at $62.33 billion, and a surplus of $46.42 billion in June with a 7.2% increase compared to last year.

China’s economy gradually emerging from a record contraction in the first quarter but sustaining this momentum is being questioned as rising coronavirus cases worldwide have severely affected demand. Chinese consumption has also subdued significantly amid job losses and very strict quarantine measures.

Recently China’s export performance has been boosted by record shipments of medical supplies and sustained demand for electronic products, has beaten much pessimistic estimates by global analysts. Even imports of industrial raw materials remained robust, with record imports of iron ore and copper, and a sharp jump in crude oil. Exports are growing by double digits, and retail sales, which had been lagging for months, are back to pre-virus levels however, poorer households which form 60% of the economy are still struggling. Their current rebound is K-shaped, exacerbating widening income inequality, which was already a problem before the pandemic.

Figure 3

Figure 4

Government support around the world has been in the form of huge reforms to existing work structures and fiscal stimulus packages. US launched four stimulus packages worth around $2.7 trillion USD that involves small business loans, unemployment insurances, nutrition assistance, healthcare funding, government investment and bailouts of corporates, basic income of $1200 USD for adults and $500 USD per child. Similar package has been Canada which has allocated as much as 3% of its GDP with a $82 billion from $500 in credit features and tax deferrals to every Canadian getting at least CA$ 2000 for about 4 to 6 months of unemployment.

India announced a $22 billion USD financial package that covers food for two-thirds of the population, increases basic income to farmers, senior citizens, self-help groups, women, medical insurance cover of Rs 5 million per healthcare worker covering more than 2 million people. Even injecting liquidity worth $85 billion USD into the economy collateral free loans for MSMEs, repo rate reduction by 75 basis points, extended government contracts, liquidity infusion for NBFCs, utilities firms etc.

For India, Pre COVID-19, GDP growth slowed to 4.7% in 2019, the lowest level since 2013. Unemployment reached a 45-year high. Industrial output from the 8 core sectors at 2019 end fell by 5.2%-the worst in 14 years. Private sector investment had been stagnant for several years and declining in recent times and consumption expenditure had also been falling, for the first time in several decades. Urban consumption demand indicators show sales of passenger vehicles and consumer durables growth contracted in February 2020. Overall, urban consumption has stagnated in the fourth quarter. Rural consumption indicators like motorcycle sales and consumer non- durable segment remained in contraction in February 2020, reflecting weak rural demand.

India’s core sector consisting of coal, crude oil, natural gas, refinery products, fertilizer, steel, cement, and electricity, output contracted 38.1% in the April, 2020. This core sector forms 40.27% of the index of industrial production. The core sector had expanded by 5.2% in the same period in 2019 while it shrank 9% in the March, 2020. This is the biggest ever fall in the core sector data ever recorded. Core sectors saw refinery production decline by 24%, steel production declined by a massive 83% while electricity generation saw a decline of 22.8% from 2019 while crude oil production slipped 6.4%. Coal production showed a decline of 15.5%, cement production was a massive 86% fall from April, 2019.

Goldman Sachs Group Inc. expected gross domestic product to contract 5% in the fiscal year through March 2021, which would be India’s deepest recession ever; while ICRA expected it to be a steeper 9.5%. Chief India economist at Barclays estimated growth declining to 2.5 per cent in 2020, and 3.5 per cent in FY20-21 eventually leading to a loss in excess of $120 billion from global and domestic trade revenues. (Bajoria, 2020). Bank of America Securities estimated India’s GDP to contract 4-7.5% if COVID-19 vaccine is delayed as of July 13, 2020. (Securities, 2020) as of April 2020.

India’s real GDP depleted to its bottom in over six years during the fourth quarter of FY 2019-20. All these estimates were defeated when the official report recorded that India’s GDP shrank 23.9% year-on-year in the second quarter of 2020, much worse than the final market forecasts of an 18.3% drop. This is the biggest recorded economic contraction in India’s history.

To create a snapshot of the contribution of different sectors of the GDP, the most important and the fastest growing sector of Indian economy are services. Trade, hotels, transport and communication. Financing, insurance, real estate and business services and community, social and personal services account for more than 60 percent of GDP. Agriculture, forestry and fishing constitute around 12 percent of the output, but employs more than 50 percent of the labor force. Manufacturing accounts for 15 percent of GDP, construction for another 8 percent and mining, quarrying, electricity, gas and water supply for the remaining 5 percent.

Construction (-50.3%), hotels and transportation (-47%) and manufacturing (-39.3%) recorded the biggest plunges. Positively, farm sector grew 3.4%. On the expenditure side, private spending shrank 26.7%, inventories fell 20.8%, exports plunged 19.8% and imports dropped a whopping 40.4%. Only government consumption jumped 16.4% as it implemented country-wide relief measures via food and medical supply to help curb the impact of the pandemic.

Figure 5

2020 Indian stock market saw one of the most highly volatile markets ever even beating the 2001 and 2008 financial crises. In 20-23 March of 2020 Sensex fell more than 4000 points and Nifty 500 fell around 1000 points. Compare that with current September 2020 market we see the market has undergone a U-shaped recovery wherein the US market plunge, fear of coronavirus, staggered opening of lockdowns in India and economic packages by government have been priced in by the market. Nifty 500 has risen from 6,243 on March 23 to 9326 as of September 30, 2020. As can be seen in figure 7, the 50-day moving average as almost crossed over the 200-day moving average forming a ‘golden cross’ technical indicator signifying a possible rally in the short term unless some significantly negative news comes to light.

Impact of Government policies and economic packages is being seen in the recovery of stock markets to some extent lately and improvement in demand-supply situation. Better corporate profit reporting, improved performance of MSME & strategic sectors, good agriculture out due to normal monsoon and rural migration would support strengthening of the economy indicated by higher agricultural and consumer staples spending since March compared to February.

The US market in mid-march 2020 noted the worst trading in the past 124 years. The Indian market also saw a 20% cut in benchmark indices making the Indian equity market enter the territory of Bear market. BSE Sensex witnessed a sharp fall in the stock market on March 23, 2020 due to the Coronavirus fear across the global market. The Sensex had fallen 3500 points to approx. 26, 000. On the other hand, the NSE Nifty fell 11 percent. The Indian market opened on a positive note with promising signals from the foreign markets only to fall flat with the foreign investors continuously withdrawing money from the Indian markets.

Benchmark BSE Sensex Index would revisit this year’s low of 25,638.90 hit on March 24, 2020. While the index has recovered nearly 20% since hitting a record low – a day before the nationwide lockdown started on March 25 – it is still down around 26% so far this year. That is despite $266 billion of economic stimulus announced by the government and the aggressive liquidity measures and interest rate cuts by the Reserve Bank of India.

Resurgence in covid-19 waves in several countries, constantly rising cases globally, Russia-Saudi Arabia price war that plunged prices to a 17 year low in March, reduced fuel requirements due to quarantine affected travel and business has been a blessing in disguise for countries like India who import oil. India itself imports 82% of its oil needs and aims to bring that down to 67% by 2022. Current ideas for this are by replacing it with local exploration, renewable energy and indigenous ethanol fuel

Indian travel and tourism sector contributed nearly 6.8% of GDP i.e. $194 billion, in 2019 down from 9.2% at $240 billion in 2018. This sector employs 8.1% of the total employment in the country and has suffered the hardest due to Covid-19

Disruptions in tourism sector will render many people in unemployed since tourism sector also has linkages to other sectors like agriculture, transport, handloom, and FMCG to name a few. The food and hospitality sector are under severe pressure from high fixed costs and minimal footfalls after months of zero business when the lockdown started in March, 2020. FAITH, federation of associations of tourism and hospitality industry has estimated a loss of Rs 10 lakh crore for the industry due to COVID-19 in just 2020. This will also impact inflow of foreign tourists, which means a drastic fall in foreign exchange earnings which was approximately Rs 2,10, 981 crores in the first three quarters of FY 2019.

Conclusion

A mid-2020 United Nations Department of Economic and Social Affairs report expects COVID-19 to slash global economic output by a whopping $8.5 trillion over next two years wiping out nearly all gains of the previous four years. The global economy is projected to contract sharply by 3.2 – 5 % this year. This will push more than 34 million people into extreme poverty in 2020 with 56% of this increase occurring in African countries erasing all the progress made in the last 4 years. An additional 130 million people may join to the ranks of people living in extreme poverty by 2030, dealing a huge blow to global efforts for eradicating extreme poverty and hunger. This pandemic, is disproportionately hurting low-skilled, low-wage jobs, while leaving higher-skilled jobs less affected. This will further widen income inequality within and between countries.

Especially in India where about 69% of the 138-crore population is poor and living at less than a horrendous, just $2 daily. An increase of even 1% in this metric means millions more Indian’s now loose access to basic healthcare, education and food and mortality rates especially infant mortality rates skyrocket

Most developing economies weighed down with high levels of public debt are finding it very hard to implement sufficiently large economic packages and other much needed stimulus measures. Debt sustainability of developing economies is rapidly being undermined by the falling exports, particularly those that are heavily dependent on commodities, tourism revenues or remittances. In the immediate term, it is paramount to ensure the increased availability and rapid deployment of international funds to address liquidity shortages. In addition to these short-term measures, many developing countries will need comprehensive debt restructuring to have the fiscal space to stimulate growth and recovery.

Some sectoral recommendations beyond tax benefits include:

1. Telecom: Upgrade existing infrastructure to implement new technologies like 5G and Augmented Reality to help healthcare professionals and service sector as a whole. Reduce TRAI fees short-term and improve regulations long-term.

2. Auto: Deferred payment system for dynamic interest loans both on consumer and manufacturing end.

3. Consumer Retail: Laxing import and manufacturing of rules for essential goods. Cover up this loss by imposing higher tax on luxury retail goods for the short term.

4. Aviation and Tourism: Significantly reduce Air Turbine Fuel (ATF) costs by reforming existing tax laws and upgrade MRO-ANS facilities to make them safer and more efficient.

5. Power & Transport: Deferred billing, using this time of low traffic for upgradation and digitization using latest technology to reduce cost on a countrywide scale.

6. Agriculture: New food bills have already been passed to connect farmers and consumers directly by removing the necessity of using APMC middlemen , ensure corporations do not misuse and hoard food due to removal of corporate produce storage cap and improve the digital infrastructure to connect 17 Crore farmers big and small to buyers and ensure they get the correct prices for the produce even with the removal of minimum support price.

From massive losses to individual sectors especially Media, Realty, Hospitality, Service sectors and Manufacturing have been hit the hardest in the current market slump to an excellent recovery in stock market recovery, we see a complete market recovery has a long way to go since Mutual Fund industry, Foreign Investment and domestic or international trade are yet to reach pre-covid-19 levels.

Strategic fiscal packages to support small business, farmers, frontline workers like police, border forces and healthcare professionals need to be continually supported. Such packages also need to be provided to big corporates such that they can support the large amounts of people they employ since as we know unemployment levels are currently at a 13-year high. Opportunities for lucrative foreign investments also need to be made to jumpstart the declining trend of FDI in India and accelerate growth in large scale industrialization, infrastructure and digitization of India.

The current time should be utilized to the maximum to upgrade our infrastructure, introduce new technologies to improve current pipelines of all existing industries and ensure the poor and marginal citizens who are disproportionately affected in this pandemic to the point of dying due to poverty or not receiving required medical support due to overflowing hospitals, receive sufficient support during and after this pandemic.

This is an excerpt from my published paper that snapshots a broad market view of stocks, mutual funds, FDI and the general economy of India during the current Covid-19 pandemic using secondary data. Full paper can be found on my LinkedIn page.

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. Nothing on this Blog constitutes investment advice, performance data or any recommendation that any security, portfolio of securities, investment product, transaction or investment strategy is suitable for any specific person. From reading this Blog we cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you, so any opinions or information contained on this Blog are just that – an opinion or information. You should not use this Blog to make financial decisions and we highly recommended you seek professional advice from someone who is authorised to provide investment advice.

Asia and Chemicals Industry

Asia’s economies are among the world’s fastest developing. The increased use of cosmetic and personal care products in Asia has had an especially significant effect on formulating firms, as they too hope to benefit from the region’s growth. Performance-enhancing chemicals were regarded as corrective agents for weaker formulations thirty years ago. Emulsifiers, viscosity inhibitors, specialty surfactants, and other additives are now considered essential components of high-performing, low-cost consumer goods.

Deregulation in developing markets has resulted in an increase in GDP, which has led to an increase in generic use, which has resulted in an increase in demand for specialty chemicals (Fost, 1997). Asia’s share of total specialty chemical demand is expected to rise from around 47% in 2018 to 50% by 2025, fueled disproportionately by China and India. Analysts agree that India has a great opportunity to grab market share from China by utilizing its assets, which includes a stable reformist political leadership, a growing consumer demographic, and a startup culture with higher English language proficiency than its Chinese counterparts (Singh, 2020).

Chemical Industry of India

IBEF on behalf of the ministry of Commerce and Industry of India comments that the size of specialty chemicals market in India is poised perfectly for growth. This is no surprise since India is the fastest growing major specialty chemicals market in the world. Chemicals make up a considerable part of India’s total trade flow, ranking third in imports and fourth in exports over the past five years. India currently has a $15 billion chemical trade deficit. The country’s trade deficit with China fell to $45.91 billion in 2020 from $56.95 billion in 2019 (UN Comtrade Database, 2020; Suneja, 2021).

The Indian chemicals industry was valued in 2019 at US$ 178 billion. However in just the next 5 years by 2025, analysts expect the number to reach US$304 billion at a CAGR of 9.3% fueled by higher consumer demand and also a shift from the currently existing China due to trade wars, pollution laws and motivation to lower dependency aggregation after witnessing complete halt during 2020 pandemic lockdown in global manufacturing due to china being the biggest hub. Out of this, specialty chemicals constitute 22% of the total chemicals market in India and expected to rise 12% CAGR till 2022 (IBEF, 2020). Between 2006 and 2019, the compound annual growth rate (CAGR) in TRS for India’s chemical companies was 15 percent—a figure much higher than the global chemical-industry return, with a CAGR of 8 percent, and the overall global equity market, with a CAGR of 6 percent. Even between 2016 and 2019, when India’s economy faced headwinds, the chemical industry maintained a CAGR of 17 percent (McKinsey Report, 2021).

Chemical trade value has increased at a faster rate than India’s average trade value. Chemical exports increased by 11 percent from 2014 to 2018, compared to just 0.4 percent for India’s average exports, implying enormous potential in global markets, while chemical imports increased by 5% in the same period. Despite higher export growth than import growth, India still imports more than it exports, resulting in a USD 15 billion chemical trade deficit (McKinsey Report, 2021). Specialty chemicals are the most important chemical export category in India, accounting for over half (55%) of total chemical export value in 2018.

Despite this, they account for just 3% of the overall volume of specialty chemical exports globally, compared to 13% for China, 11% for Germany, and 5% for Japan. There is still scope for improvement (McKinsey Report, 2021). Additional support, in terms of fiscal incentives, such as tax breaks and special incentives through Petroleum, Chemicals and Petrochemicals Investment Region (PCPIR)s or Special Economic Zones (SEZ)s will enhance production and development of the industry. With this in mind, the government has created a 2034 roadmap for the chemicals and petrochemicals sector to look at ways to increase domestic demand, reduce imports, and encourage investment in the sector (IBEF, 2020).

Indian Export of Chemical Products (In US$ Million), Ministry of Commerce and Industry

The top segments in India under the specialty chemicals segment are textile chemicals, agrochemicals, specialty polymers and surfactants. Other segments expected to grow rapidly are flavouring and fragrance agents, cosmetic chemicals, adhesives, water management chemicals and food additives. All these are banking on growth fueled by forecasts of rising market demand and shift from outsourcing to import aligned with make in India movement (McKinsey Report, 2021).

India’s advantages:

1. Rising Demand

a) In India’s specialty chemicals sector, the demand from end-user industries such as food manufacturing, personal care, and home care is propelling the growth of various segments.

b) Strong demand for specialty chemicals in the automobile, personal care, water treatment, and construction segments is likely to be supported by a growing middle-class population.

c) In the top three specialty chemical export markets – agrochemicals, dyes and pigments, and intermediates for active pharmaceutical ingredients(API) – India already has a good foothold (McKinsey Report, 2021)

2. Opportunities:

a) As multinational businesses aim to de-risk their supply chains, which are heavily reliant on China, India’s chemical industry has the potential to expand significantly.

b) The imposition of tighter environmental regulations in China, which resulted in the closure of over 40,000 units, could open doors for Indian chemical suppliers to service foreign players. Due to tougher environmental regulations, tighter funding, and restructuring, the architecture of China’s chemical industry is shifting.

c) The latest trade wars between China, Europe, and the United States have had an impact on bilateral trade, presenting prospects for Indian players to overcome the supply chain gap.

3. Policy Support

a) The government intends to implement a production-linked incentive (PLI) scheme to encourage domestic agrochemical manufacturing with 10-20% performance incentives

b) The Department of Chemicals and Petrochemicals received Rs 218.34 crores (US$ 28.97 million) in the Union Budget 2020-21.

c) With a few variations, such as toxic substances, the automatic route allows 100 percent FDI in the chemicals industry.

d) Between April 2000 and September 2020, total Foreign Direct Investment (FDI) inflows into the chemicals (other than fertilisers) market totaled USS 18.06 billion.

e) Make in India: Two major initiatives exist under Make in India that can help specialty chemicals:

i. PCPIRs (Petroleum, Chemicals & Petrochemicals Investment Regions) are clusters created by the Indian government to provide investors with a transparent and investment-friendly policy and facility framework. PCPIRs have world-class infrastructure and a competitive environment that makes it much easier to set up a business. The total expenditure needed to fully realise PCPIRs is estimated to be INR 7.63 lakh crore.

ii. CPDS – The Chemicals Promotion Development Scheme aims to promote and expand the chemical and petrochemical industries by providing financial resources for lectures, workshops, exhibits, undertaking studies/consultancies, and analysing important issues concerning the chemical and petrochemical industries (Make in India, 2020).

4. Increasing Investments

a) Specialty chemical companies in India are expanding their capacity to meet growing demand from both international and domestic markets. PCPIRs are projected to draw US$ 104.36 billion in investments.

b) Trade agreements reflect this change in interest from China to India. Strategic investors, led by Japan, Korea, and Thailand, have shown a strong interest in Indian companies in the sector since November 2020, as they look for diversification avenues for their supply chains, away from China. This included major transactions in FY 2020, such as Carlyle’s US$ 210 million acquisition of SeQuent Scientific Ltd and KKR’s $414 million purchase of JB Chemicals and Pharmaceuticals Ltd.

Scope for growth – specialty chemicals segment, IHS Chemicals, IHS Global Insight

With these insights in mind, current scope for growth:

As data suggests, in the top 3 global segments namely API Intermediates, Agrochemicals and Dyes and Pigments, China’s export value is 2.7 times higher than India’s and thus has potential for India to seek deeper penetration into these high volume segments. In the other segments where China’s export value is 12 times higher than India’s, there room for India to explore how to break into these product segments especially in Nutraceuticals and Flavours & Fragrances segments where China holds a whopping 46% market share in both while India only has 2% and 12% export value share, respectively. Getting a foothold in these segments will lead to immense value creation specifically for the reasons of other global players trying to de-risk from Chinese supply chains.

This is an excerpt of the Chemicals industry. Full paper about Indo-China trade and pharmaceutical sector can be found on my LinkedIn page.

‍Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. Nothing on this Blog constitutes investment advice, performance data or any recommendation that any security, portfolio of securities, investment product, transaction or investment strategy is suitable for any specific person. From reading this Blog we cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you, so any opinions or information contained on this Blog are just that – an opinion or information. You should not use this Blog to make financial decisions and we highly recommended you seek professional advice from someone who is authorized to provide investment advice.