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Posted on 07-Jun-2019 Comments  0

Specialty Chemicals

Why specialty chemicals could be the next big stock market story

Between 2014 and 2019 a rather small company called Aarti Industries zoomed by 1700% from a price of Rs.95 to Rs.1720. The unique feature about Aarti Industries was that it derived 78% of its revenues from the specialty chemicals business and was seeing unprecedented growth in the last five years. What exactly is this story all about?

Why specialty chemicals?

Specialty chemicals are niche products with very specific uses in industries. Some of the examples of specialty chemicals include products like carbon products, coal tar pitch, carbon black, specialty oil etc. Specialty chemicals are inputs for key high growth industries like electronics, paints, coatings, plastics, aluminum and automobiles. The opportunity is huge. The global specialty chemicals industry is worth nearly $770 billion and India currently accounts for less than 1.5% of the global market. In the last few years, there have been massive investments made by Indian specialty chemicals players like Himadri, Navin Fluorine, Aarti Industries, and Vinati Organics in expanding capacity to global standards. What is more important for India is that it has an established ecosystem for basic chemicals which are an important input for specialty chemicals making the scaling up more feasible. Since the industry is highly skilled, there is limited competition from informal sector, unlike in the case of basic chemicals.

China makes room

It must be said that to a large extent the India edge came from China. By 2010, China had already emerged as the world’s largest manufacturer of specialty chemicals, taking over from the US in terms of scale. China is still the world leader by a margin but there have been serious environmental concerns raised. Hence China has been crimping its specialty chemicals output sharply to ensure that its factories are in line with the environmental safety norms. This has led to a sharp fall in production in China and India has been the obvious beneficiary of that trend. In fact, a lot of the growth in last 3 years has come to India largely by the room vacated by this environment decision taken by China. This comes at a time when global agrochemical producers are also looking to outsource specialty chemicals due to the high compliance costs. It is surely advantage India on this front!

A huge trade war boost

The trade war has put nearly $15 billion worth of Chinese chemical output at global risk and India has the opening to move in. In addition, Chinese producers themselves are seeking to outsource the manufacture of specialty chemicals to India to get around the trade war norms and that could be another big market for India to tap. With its edge on input procurement and a huge market, this could be the next big story!

Debt Funds

Debt funds could become the next big crisis if ignored now

For a long time, debt funds were treated as the gold standard in mutual fund investing. Limited risk and assured returns made them a natural choice. In the last few months, IL&FS and DHFL have changed the narrative. It is time to rectify the crisis urgently before it becomes a case of trust on trial.

How debt fund took a hit

For a long time, the credit opportunities funds were treated like bond funds with an edge. The problem started when IL&FS defaulted and got exacerbated with the latest DHFL interest default. When bonds of private entities are downgraded, there is a huge write-down that fund need to take and the investors are the ones to take the NAV loss. With the recent delay in FMPs due to Essel exposure, debt funds are truly on trial.

A systemic risk too

What we saw in the case of IL&FS, Essel Group and DHFL is not just a case of losses for investors but also a cascading effect. When NBFCs default, the sectors like automobiles and realty funded by these NBFCs also are pushed to the brink of default. The impact, thus, is a cascading one. The 3 cases have actually resulted in yields on private debt paper moving up and that is pushing up borrowing costs. This also creates a solvency risk for companies which are already vulnerable due to the crisis in the overall NBFC segment.

Quest for higher yields

To a large extent the fund managers have only themselves to blame for this state of affairs. As competition increased among funds to woo debt fund money, private debt came as an easy answer. Yields were at least 100-150 bps higher than the normal G-Secs and that gave a huge boost to the returns that these funds could offer. This in turn attracted more flows. Nearly 20% of all debt fund money is invested in private sector debt and that could be a real challenge if the problems worsen. Also, there have been a large number of cases where MFs have virtually funded the promoters through debt funds and Essel is the most glaring example. The quest for higher yields has come at a steep cost.

Time to act is now

The bigger takeaway is that SEBI has to act urgently. Let all debt funds make a transparent and audited disclosure of their portfolio values and make adequate provisions. Funds must be forced to offer an exit to MF investors without exit load (not the UTI style). It is the time to probe deeper and make mutual funds accountable where the fall in NAV is due to imprudent decisions. It is time to make the fund managers more accountable, like bankers are held accountable in case of bad loans. SEBI must also ring-fence the good portfolio of debt funds. Above all, it is time to act fast to sustain retail trust in MFs!

Monetary Policy

Monetary Policy combines rate cuts with accommodative stance

The monetary policy announced on 06th June was along expected lines but also disappointed the markets. That was evident from the market reaction on the policy day. However, the RBI has tried its level best to balance growth, liquidity and the realities of the future inflation risks. But first, what were the key highlights of the monetary policy.

Rate cut less than desired

The Monetary Policy Committee (MPC) maintained its dual focus on lowering rates and making liquidity available. Repo rates were cut by 25 bps to 5.75%. This also took the reverse repo rates lower to 5.50% and the MSF cum bank rate to 6.00%. The markets were expecting a bigger rate cut of 35-50 bps but the RBI had its own reasons for the reluctance. Firstly, the first two rounds of rate cuts in February and April had not resulted in proper transmission of the rate cuts to the borrowers. That defeats the purpose of rate cuts. Secondly, the specter of inflation is still a reality and there is already a worry on the monsoon front. IMD and SKYMET have forecast below-average monsoons and that could impact food grain prices and lead to higher inflation. RBI needs to be prepared for that. Lastly, there was the risk that if rates were cut too fast then FPIs may find Indian debt less attractive. That has been one of the most volatile sources of flows and the rupee may not be able to withstand another bout of selling by FPIs.

Focus on stance of the policy

For those traders and analysts who were disappointed by the lower than expected rate cut, there is good news. The RBI has shifted its policy stance from “Neutral” to “Accommodative”. This keeps the doors open for further rate cuts in the future subject to supportive macro data flows. By postponing the rate cut decision to a future date, the RBI also gets the additional benefit of data flows in the form of CPI inflation for 2 more months and a more reliable update on the monsoon progress. These will be key inputs for the RBI to take a view on the rate decision. The real indication is the shift in stance which clearly indicates that the MPC is no longer ambiguous but clear that rates are headed down!

Beyond rates and liquidity

The big takeaway is the move by the RBI beyond rates. Firstly, it has left it to fiscal policy to give the additional thrust. That will be visible in the Union Budget on July 05th. Secondly, the RBI has scrapped its charges to banks for NEFT and RTGS transaction with the caveat that these benefits will be fully passed on. ATM policies will also be reviewed. Above all, the RBI will also make the liquidity ratio more pragmatic and will also ensure that retail investors get an agnostic platform to trade in currencies. The real story of the policy may be actually outside the rates debate!

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