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Posted on 05-Apr-2019 Comments  0

Sensex at 40

Why the Sensex at 40 is also the story of 40 years of India

On April 01st, the Sensex completed a full 40 years of existence. Over the last 40 years, nothing has captured the sentiments of the market and the undertone of economic shifts better than the Sensex. Like most indices, the Sensex has been a powerful lead indicator of the Indian economy. The Sensex, which was launched in 1979 with a value of 100, is worth 39,000 today. That speaks a lot!

Why 1979 was a great time 

In a way, the Sensex was lucky to have started in 1979. It was a time of global flux and most of them favored equities as an asset class. China was just embarking on liberalization under Deng and Russia had invaded Afghanistan. Neighboring Pakistan had just seen the execution of Bhutto and the Iran Revolution was gathering steam. It would lead to the deposition of the Shah and installation of an Islamic regime. It was still 10 years before communism began to implode, but the rumblings were visible back in 1979. The focus of Middle East oil economics was changing and the US was getting closer to the Saudi Kingdom, a far cry from the Oil Embargo of 1973. But above all gold was nearing its peak after a frenetic 8 year rally which had taken the price of gold from $30/oz to $920/oz. In fact, by the time India ushered reforms, Sensex was already a 10-bagger and had turned in a 45-bagger by the time the Harshad Mehta scam broke in 1992.

Reflecting economic shifts

Above all, the Sensex has highlighted the shifts in the structure of the Indian economy over the last 40 years. Only 10 of the original Sensex companies still remain in the index. The 1979 Sensex did not have a single financial company; which today accounts for 36% of the index. Information technology, another big story of the last 30 years, was non-existent in the Sensex back in 1979. If you look at the 3 most valuable companies in the Sensex today, only Reliance was listed. HDFC Bank was formed much later and TCS was still an unlisted unit of Tata Sons. In terms of sectoral mix, Sensex used to be dominated by textiles, metals and engineering. Most of these sectors hardly exist in the Sensex today. In a way, the Sensex is the best reflection of the shift from a hard power to a soft power; that India has exhibited.

Above all, an equity story

But the biggest message from the Sensex @ 40 is that equity continues to be the best asset class for long term wealth creation. An investment of Rs.1 lakh in the Sensex in 1979 would be worth Rs.3.90 crore today. That is 17% CAGR without dividends and 18.5% with dividends. If ever one needed evidence that even passive equity investments can generate wealth in the long run, just look at the Sensex. That is the big take-away from Sensex @ 40! 

Monetary Policy

Monetary Policy goes much beyond rates and liquidity

The monetary policy had little by way of surprise when it announced a 25 basis point cut in rates. That was already factored in the market. In fact, the market was hoping for a bigger cut or a shift in stance to “accommodative”. That was not to happen as the RBI stuck to its neutral stance. If you look at the rate cut from a broader perspective, it just restores the status quo prior to June 2018. The RBI had earlier hiked rates by 50 bps in June and August. So, the cuts in February and April only restore the original status of rates. 

Rates and liquidity

Interestingly, the monetary policy has focused on rates and liquidity. This is, after all, the first monetary policy of the new fiscal year and the last monetary policy before the general elections. The rate cut of 25 basis points has been made without changing the stance. Effectively, the RBI has retained the privilege of moving rates either ways depending on the level of inflation post the elections. The liquidity taps have been supported at various levels. While the RBI has committed to continue with its Rs.40,000 crore OMOs per month, it has also hinted at sustained dollar swap auctions. Together, these will infuse nearly Rs.80,000 crore per month of liquidity and take care of the shortfall in the financial markets. The additional leeway of 200 bps in HQLA as part of the NDTL deposits will also be a boost to lendable resources of banks.

Why not more aggressive

That is a question that will be debated but most likely the RBI wants to assess the impact on transmission. It was disappointing first time around. Also, the RBI believes that the huge liquidity infusion will anyways bring down yields at the short end. In addition, since banks will be flush with liquidity, they will have no choice but transmit the rate cuts to the end user. Like in the case of demonetization, transmission is best achieved through surplus liquidity and that is what the RBI is targeting at this point of time.

Focus on bigger reforms

The policy has dealt in elaborate detail on other aspects of financial reforms that are outside the ambit of traditional rates and liquidity management. Firstly, the RBI has set up a task force for secondary market listing of corporate loans. This will ensure an exit route for banks and also finer and timely pricing of loans. Secondly, the monetary policy has also talked about expediting a full-fledged securitization secondary market. This will provide an active secondary market for housing finance companies to monetize their housing receivables and also provide an additional avenue for investors. In a way, the monetary policy has chosen to go way beyond mere optics on rates and liquidity and has focused on larger reforms. For that, the RBI must be given due credit!

Bank NPAs

There is a need to strike a balance between freedom and license

The talk of town in the last few days was the Supreme Court order striking down the RBI circular issued on February 12th 2018. The circular had made it mandatory that any borrower above Rs.2,000 crore defaulting on the loan for more than 180 days would be automatically referred to NCLT. The Supreme Court has struck down this circular on the grounds that they were ultra vires the powers of the RBI. It is a case of very strong words used by the SC for a statutory regulator.

Regulation has to overreach

If the issue is overarching powers to the RBI, then stringent regulation has to stretch to extremes. There was no other way to resolve the current NPA problem. At 10% gross NPAs; India is worse than Greece in terms of a banking crisis. The big problem today is that there is delay in disclosure of NPAs and by the time action is taken, it is just too late. Recently, it became clear that nothing was going to be recovered from the dues of Videocon and IL&FS Financials in the absence of any assets. These instances could have been easily prevented if timely action had been taken and the cases referred to the NCLT. Above all, the NCLT circular would have forced the banks to disclose any default immediately rather than use track 2 restructuring methods to recover these dues. Of course, the SC order still leaves government discretion but that may not be enough in most cases.

Creates Rs.3.8 trillion problem

The Supreme Court may have actually created an additional Rs.3.8 trillion problem for the banking system. The aggressive stance taken by the RBI and the NCLT in the last few years had not only forced the promoters to the negotiating table but also improved the balance sheet of PSU banks. With this one judgment, the SC has turned the tables in favor of the promoters all over again. For a long time, scores of promoters had been gaming the system and borrowing recklessly from the financial institutions. The aggression of the RBI and the NCLT had infused a sense of urgency and fear in promoters. With this SC order, nearly 70 such promoters are again going to get a fresh lease. Nearly 50% of these stressed loans of Rs.3.8 trillion belong to the power sector

Leave it to the regulator

Ideally, the SC should have left it to the discretion of the RBI. Of course, an aggrieved borrower always has recourse to the law and that’s protection enough. What the SC order does is to make the RBI more cautious and the promoters more brazen. But the biggest casualty of this order will be the onus on banks to disclose defaults immediately so that the 180 days settlement period can kick. India needs a model where public money in banks is protected. SC order has taken banks two steps back!

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