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Is Venture Capital Market in India Getting Overheated document sample
Is Venture Capital Market in India Getting Overheated document sample
Part 1: MACROECONOMIC ANALYSIS…….. THE UNION BUDGET 1992-93 AND THE CAPITAL MARKETS By Professor Russi Jal Taraporevala On 9th March, 1992, Professor Russi Jal Taraporevala presented his Budget Analysis, followed by the Sectoral Analysis, as also his view of the Budget's implications on the capital market, and what an investor should do under the circumstances. Professor Taraporevala said that Dr. Manmohan Singh needs to be complimented for presenting the best of the Budgets India has seen since independence and that the stock market has justifiably applauded the same. But he wondered as to whether the applause the same. but he wondered as to whether the applause was a bit too loud. On 10th March, the BSE Index slid by 231 points, and on 11th March it slumped by 152 points. In the past, on twenty-seven occasions, Professor Taraporevala has succeeded in predicting market behaviour correctly Capital Market is happy to present here the exclusive coverage of his views, as contained in his lecture to the Bombay Stock Exchange. The Economic Survey of the Government of India highlights a weaker, compared to the previous year. it admits that the monsoon plays a crucial role in agricultural production. The budget must, therefore, be analysed in the context of the extraordinary run of four good monsoons, of which the last one was the weakest. Gross National Product (GNP) at 1990-91 prices, according to the new series, showed a 10% growth in 1988-89, 5% in 1989-90,5.8% growth of the Indian economy has slowed down. The GNP during the Seventh Plan rose by 5.5% per annum. But net per capita product rose only at the rate of 3.4%, because the population continues to grow unabated at around 2% per annum. The Finance Minister, in his budget speech, said, "The overall I expect GDP growth in 1991-92 to be arounf2.5% I expect a distinct improvement in 1992-93 and a return to high growth in 1993-94.'Further he said, "It will take sustained effort over atleast three years to bring the economy back to the path of rapid and sustainable growth. "However, three years is a long time and the Finance Minister should make every effort to compress period. Officials of the finance ministry said after the budget, that GDP was expected to rise by 3.5-4% in 1992-93. This is a much slower rate of growth than achieved in the past years. The Eight Plan will commence on 1 st April 1992 and aims at an average growth of 5.6%. Agriculture The index of agriculture production, which had fallen by 0.8% in 1988 because of a bad monsoon dramatically by 21% in 1988-89, 2.6% after rising by 2.1% in 1989- 90, 2.6% in 1990-91 but is estimated to show growth in 1991-92. Similarly, food production d ruing these years rose from 140 million tons in 1987-88 to 169 tons in 1988-89, 171 million tons in 1989-90 and 176 million tons in 1990-91. It is estimated that, at best it may be million tons, in this current year, provided that the rabi crops is very good. Thus the overall food grain production during 1991-92 may be lower than the target of 182.0 million tons as the last year's level of production. Industrial production The index of industrial production increased by 7.3% in 1987-88, 8.7% in 1988-89 8.6% in 1989-90, and 8.5% in 1990-91. But is estimated to have fallen by 0.9% during the April- Nov'91 period. This recessionary trend is more announced in the manufacturing sector. The Economic Survey points out that the trend in the production in the manufacturing sector was much steeper at 2.3%. a growth of 11.5% during the Apr-Nov period of the past year. The Survey mentions that if every thing goes well next year, the rate of industrial production is expected to grow by 3-4% against the past growth rates of 8%. Infrastructure The Economic Survey mentions that the performance of the infrastructure shows mixed trends. Energy, railways and shipping have exceeded their tariffs. But the petroleum sector performed poorly as the production was lower than the level achieved last year. the production of crude oil, which was 32 million tonnes in 1988- 89 and 34 million tonnes in 1989-90, is estimated in 1990-91 to be 33 million tonnes. In the Apr-Dec'91 period the crude oil production jumped to 22.97 million tonnes from 24.7 million tonnes in the corresponding period of the previous year. Imports of crude oil and petroleum products had, therefore, to be dramatically raised causing foreign exchange drain. The country has spent Rs.6344crores to import 26.36 million tons in 1989-90. In 1990-91 the import were 29.36 million tons, amounting to Rs.10717, crores. In 1991-92, the imports are estimated to jump to 32.8 million tons. Therefore in the last three years our imports or petroleum products have risen from 26 million tons to 32 million tons, which caused a sizeable foreign exchange drain on our Exchequer. The sudden decline in petroleum production which is causing substantial pressure on imports is due to the inefficient working of the Public Sector, disturbances in Assam, and wasteful flaring of gas. Under these circumstances, the government has at last realised that it cannot allow the public sector to monopolise the oil industry. The Finance Minister said the government would welcome proposals for private investment including foreign investment in production, refining and marketing of oil and gas, with a view to maximising the growth potential in this crucial area. The Economic Survey correctly points out that the potential for overall growth in the industrial sector is crucially dependent on continuing adequacy of investment and performance in the infrastructure industries. Therefore, the government decided to allow the private sector to play a role in the infrastructure industries like electricity generation, road building etc. what is interesting in the Eight Plan document is that there is a shift in emphasis in the structure of the investment plan. The total investment is to be of Rs.792000 crores at 1991-92 prices. The public sector is to invest Rs.342000 crores, foreign savings are estimated to contribute Rs.49000 crores and the balance is expected to be contributed by the private sector. Thus, the Economic Survey points out that the balance has shifted in favour of the private sector, allowing a large scope for this sector than was given to it before. Industrial Investment Since the licencing system is dismantled , the tempo of industrial investment should be compared for Apr-Dec'91 with that of previous year. The first indication is the industrial enterprenueral memoranda filed of investment intentions. These rose from 2763 to 4699. Second, foreign investment rose from only Rs.87 crores to Rs.474 crores, and recently the same has been estimated for the currently year to rise to almost Rs.900 crores. Foreign technology agreements signed rose from Rs.345 crores to Rs. 541 crores. Assistance by the financial institutions during the same period rose as follows: sanctions rose from Rs.7118 crores to Rs.7805 crores, disturbances from Rs.4311 crores to Rs.6030 crores and the CCI approvals of new issues from Rs.9502 crores to Rs.12576 crores. There is a clear increase in investment momentum. Fiscal and Monetary Policies: The Economic Survey on fiscal and monetary policies points out that money supply flows during the current financial year have been faster than the previous year, even though the RBI credit to the central government and bank credit to the commercial sector have expanded at a lower rate. This is primarily because of the substantial build up in the foreign exchange reserves. Here again, despite the tight credit policies, there has been a growth in money supply. Interest rates were repeatedly raised till the minimum lending rate soared to 20% in Oct-91. The Finance Minister realised that such a savage credit squeeze and high interest rates were hurting the economy. He, therefore, announced a slight easing of the credit squeeze in his budget speech and reduced the statutory liquidity ratio on incremental domestic liabilities of the commercial banks from 38.5% to 30%. This will release funds for the banks to expand credit to agriculture and industry. Though it is difficult to assess the impact of these measures, it is estimated that the funds released would be about Rs.2600 crores. The RBI also cut the floor levels of interest rates by 1%. Both these developments are most welcome and are bullish for the market. Balance of Payments Our foreign exchange reserves which in 1987-88 amounted to Rs.7687 crores, Rs.7040 crores in 1988-89 and Rs.6251 crores in 1989-90 had fallen to Rs.1666 crores by 16 Jan-92. In Jun-91, when the new government look over, there was a serious crisis, and even the risk of default in repaying foreign obligations which could have led to dire consequences for the country despite the former government borrowings heavily from the IMF. The new government took a number of bold policy measures to tackle the crisis. As a result of which our foreign exchange reserves rose to and appreciable level Rs.11000 crores restoring international confidence in the Indian economy. Some of these reserves were built by our borrowing further from the IMF. Despite devaluation of the rupee in Jul-91 by 23%, unfortunately our exports have not picked up. The Finance Minister said in his speech that export earnings have suffered badly this year, mainly because of disruption of trade with the former Soviet Union and also because of the recessionary conditions in the world market. As a result, we have not been able to finance our normal import requirement. He pointed out later that the only lasting solution to our balance of payments position lies not in compressing imports but through a rapid expansion of our exports. The external situation today, therefore is, perhaps the most important and sensitive factor in India's development. Bulk imports of petroleum products, fertilizers, edible oils, iron and steel products and capital goods dominate our import picture. Fluctuations in their prices can throw our balance of trade picture into chaos. The country has become sensitive to fluctuations of prices of these imports because of our difficult foreign exchange situation. The Finance Minister has taken a very bold step in introducing partial convertibility of the rupee with effect from 1 March'92 in respect of current account transactions. Effective from that date 40% of the foreign exchange inflow would go to government at a fixed rate to finance essential inflow of canalised items and medical supplies, and 60% inflows would be available for import dividends, royalties etc a floating rate. Earlier they were getting 30%. Extra scrips against exports. After this was introduced, the rate for the U.S. dollar stood at Rs.25.96, while for the 60% free float, it stood at Rs.29. The Rupee has thus been devaluated for private industry in relation to current account and for all non-government transactions by 10%-15%. The devaluation of the Indian Rupee is always bullish for the stock market. It increased the value of the existing plants within the country because the imported components in them become all the more valuable. Devaluation also protects the domestic industry like a tariff barrier and makes exports competitive. So stock markets round the world have considered devaluation of currency as a bullish factor for the market. The government should aim at speedily implementing total convertibility of the rupee. FERA The FERA Act is to be amended to remove many of its restrictions and speed up the progress towards total convertibility of the rupee. What would be extraordinary bullish would be total convertibility which would include convertibility on capital account. The SEBI Chairman has estimated that if capital transactions are made freely convertible the capital inflows would occur between two or four billion U.S. dollars annually. The Finance Minister hopes to get U.S.$ 3 billion to finance the trade gap. He wants to take a couple of years before introducing convertibility on capital account. Total convertibility will also encourage greater inflow of NRI funds. Budgetary Balance The budgetary position of the government shows that the revenue deficit suggested for 1991-92 of 13854, crores rose to 17081 crores and for the next year is estimated at Rs.13882 crores. The budgetary deficit shows that the estimated deficit of Rs.7719 crores became Rs.7032 crores for 1990-91 and the next year, it is estimated at 14872 crores at current levels of taxation. For the first time in Indian fiscal history, the estimated deficit has not been exceeded, as has been happening during the past budgets. The public finances of the of the country have been kept well within the budget, which is an excellent development in terms of fiscal discipline----which was not in existence for the past 15-20 years. Direct taxes In the filed of personal taxation, the exemption limit has been raised from Rs.22000 to Rs.28000 /-. The slabs of income tax have been rationalised so that there are only three slabs of 20%, 30% and 40%. The surcharge is to continue the maximum rate of income tax for individuals has been reduced from 56% to 44.8%. The Finance Minister clearly said that there will be a cut in the rates he has reviewed certain, concessions. The main concession under Sec 80L, which allowed a deduction of Rs.13000/- in respect of dividend and interest payment etc, has been removed. He has balanced this concessions by a cut in the tax rates besides raising the exemption limit. The concession under Sec.80 CCA which allowed deduction of Rs.40000/- from the income in respect of NSS have been shifted to Sec 88. He also revised Sec 80 CCB, under which a deduction of Rs.10000/- was available if investment in equity linked schemes. The next change is in the taxation of long-term capital gains. This is simplified and the rates have been lowered slightly. Individuals will be taxed at 20%, companies at 40% and other at 30% of long -term capital gains. Substantial concessions have been given in respect of calculating the cost of the asset. Firstly, the cur off valuation dates have been shifted from 1974 to Apr-1,'81. The system of indexation of cost of is to be introduced and linked to 75% of the consumer price index. This means that rates will be published by which the cost will be adjusted notionaly in various years, depending on inflation. This is a very substantial concession. This type of taxation and indexation exists abroad and it attempts to tax, not monetary gains, but capital gains in real terms. Dramatic changes in Wealth Tax are introduced where by productive assets like shares, securities, bonds, bank deposits, units of mutual fund etc will be totally exempted from Wealth Tax Only non-productive assets like guest houses, yatchs, planes, bullion etc would be subject to Wealth Tax. Corporate taxation has bee left untouched, as the Finance Minister is awaiting the recommendation of the Chelliah Committee. Certain changes made for revenue purposes like providing past depreciation and investment allowances in excess of Rs. 1 lac can be set off by only 2/3rd in the assessment year'92-93 and the balance would be allowed in the assessment year'93-94 the effect of this is small--about Rs.1500crores. Mutual funds are now to be totally exempt from Income Tax. Therefore, he has created a level playing field for the public sector joint sector and private sector mutual funds. Indirect Taxes Custom duties have been raised to yield Rs.776 crores. Some duties have been reduced by Rs.2799 crores. Thus the net decrease in revenue on account of custom duties is Rs.2023 crores. The main changes are that the peak rates have been reduced to a maximum of 110% incurring a loss in revenue of Rs.1700 crores. The capital goods duties have been reduced, involving a loss of Rs.840 crores. There are changes in excise duties which raise the burden by Rs.2516 crores, but there are decreased in excise duties involving a loss in revenue of Rs.305 crores, giving a total net increase of Rs.2211 crores. The special excise duty rate has been raised from 10% levying a thin layer of indirect taxation on almost all items. The Finance Minister has said that he awaits the recommendations of the Chelliah Committee but he would like to reduce corporation tax to 30-35%. This is a very heartening and bullish prospect. If next year, he can cut the corporation tax from its present high levels around 30 to 35%, he would make it comparable with what exists in many other countries, and make other countries and help to attract foreign capital into India. The budget, therefore, represents a transition from the insulated socialistic policy to an open market policy regime. The Finance Minister has also warned Indian industries that it is his goal to reduce the custom duties to 25%. Industry has been given time to modernise, to grow to a minimum economic size and to be ready to compete in the world markets. These developments should be welcomed by all. Unfortunately, although this development in enormously bullish for the tock markets and for the growth of the economy, it is sad to find that some of the older industrial groups and some of the old----fashioned economist, professionals and socialist politicians are afraid of these developments. They have to adjust to these developments if they wish to survive. Part 2: SECTORAL ANALYSIS……………………… The Sectoral analysis assumes that the next monsoon will be moderate: it may be slightly lighter then the last one and that there will be no political upheavals. The foreign exchange situation will continue to be under control and inflation will remain around10% and that the new economic policies will be vigorously implemented and GNP will grow atleast 3.5%. Cement Additional excise could be absorbed The industry has had a bumper first half year. The demand softened in second half of the fiscal year and prices of cement dipped. Overall, the industry has had a very good year. The budget has levied a excise duty to yield Rs 376 crores. Because theindustry was earning bumper profits. The burden of excise duty plus freight can be evaluated roughly at Rs.6 per bag, although the industry claims a burden of Rs.10 per bag incase of increased costs. Considering the prices of cement which have rated between Rs.85 and Rs.115. the burden could be absorbed, if the demand is buoyant. It can be passed on to the consumers in the short run, softening of demand may cut into profits. But the industry can now export. Today, the profits from cement companies are largely flowing from capital intensive plants built years ago. Therefore, corporate tax has started bitting into the gross profits, and reducing the net profits of some of the older companies. For the long term, a bright future awaits the industry, because demand growth is unlikely to be matched by new capacity. For example, a million tonne plant of cement, five to seven years ago would have cost of Rs.100 crores. Today it is estimated to cost anywhere between Rs.300 to 350 crores. Thus cement prices would have to rise substantially to make new plants viable and the industry does not foresee a huge flood of entrants. Nevertheless, some cement shares in the market are trading even above the replacement cost of the new plants, which is ridiculous. For instance a one million tonne plant is traded at a market capitalisation of Rs.600 crores. This is unrealistic because there is no value in this. Investors may take replacement cost in relation to capitalisation of companies before buying shares. They should not pay fancy share prices which may be double the replacement cost of the company. Steel A bright future It has at last been decontrolled. The main private sector integrated plant will show excellent results and plans a gigantic expansion of one million tonnes. Profits should be higher by Rs.60-100 crores in the next year. some of the public sector steel shares may present good opportunities to investors when they start trading on the share markets, for all the sector of the industry. The budget, under the guise of rationlisation increased the excise duty on cotton yarn to yield Rs.80 crores and on fabrics 20 crores, imposing a total burden of Rs 100 crores. While the yarn producers may be able to pass on the duty, the fabric sector remains doubtful. There are only a few modernised mills making money today in the export market. Domestic demand is met increasingly by the powerloom and handloom sectors. Therefore. Investors should avoid this industry for fresh investments, except those mills that are totally modernised and have export performance. Nylon No strong growth The budget has made changes in the excise duty, to simplify and personalise the tariff structure and reduce the excise duty difference between various textile fibres and yarns. Nylon producers has had a very poor year. several units in the nylon an polyester filament yarn industry are passing through difficult times. The Finance Minister has taken notice of this. The excise duty on NFY has been reduced by Rs.8 per kg. The import duty on caprolactam has been reduced from 80% to 50% but of course, the devaluation has pushed up the cost of the imported inputs. The industry made either low profits or reported losses in the past year. even nylon tyrecord is glut and the industry is not showing any strong growth. Polyester Filament Yarn & Polyester Staple Fibre Intermediate manufacturers benefit PFY and PSF had a bad year. Demand has been much less than installed capacity. The excise duty on industrial PFY has been reduced by the Finance Minister to the extent of Rs.255 crores. This should help the industry, though it may not be able to retain these concessions. New producers in the industry are increasing. The PSF producers are trying hard to raise exports in order to improve capacity utilisation and there are some signs that the exports are picking up. These industries are not glamorous any more. But the industries which have made a very high profits, are the producers of intermediate products like PTA,DMT and MEG. They will continue to make reasonable profits. VISCOSE FILAMENT YARN & POLYESTER STAPLE FIBRE Oligopoly to help pass on duties These are cheap fibres which compete with cotton. The flare up in cotton prices has resulted in the increase in the prices of these fibres over the last year. the industry has had an excellent year. the Finance Minister has tried to tap its profits by raising the excise duty. The excise duty on VFY is raised from Rs.12 to Rs.15 per kg to yield a revenue of Rs.15 crores. The excise duty on VSF has been raised from Rs.10.50 to Rs.12 per kg to yield Rs.57 crores. The producers will make a strong effort to pass on the duty but they may have to bear some part of them. The duties can easily be borne by the producers as they are in an oligopolistic situation and they can do price fixing in relation to imported cost of these yarn and also domestic prices of cotton. Fertilizers Stand- alones will be hard-hit. Demand today exceeds supply and there are substantial imports. Prices were raised by 30% last year. however, the budget continues the provision of fertilizer subsidy. The domestic subsidy is estimated to cost Rs.3.500 crores for it is also a provision of Rs.1500 crores for subsidising imported fertilizers. The industry is extremely worried about changes in pricing and subsidy norms. In the past year, there were substantial delays in the payment of subsidy by the government to the producers, which caused a number of units, especially SSP units to close down. The government should pay the subsidy promptly in the years to come. The stand alone new fertilizer plants will not be visible and may not show profits for many years. The entire question of fertilizer pricing is under consideration by a committee and a solution is expected to be found to this problem. Fertilizer plants that are linker to other plants like chemicals, would be the safest best for investors. On the other hand, it is also noticed that old plants in the fertilizer industry are desperately trying to diversify into non- fertilizer areas. But this is the core industry and the long term demand for this product will be buoyant. Pesticides Would accelerate in coming years The industry's performance has been moderately good; however tax has eroded the gross profits of some of the big companies. Import duties on certain basic feed back stock have been reduced which will result in revenue loss of Rs.26 crores. The excise duty on certain plastic resins has been raised to yield Rs.165 crores in the budget. Petrochemical products are in heavy demand and a lot are imported. Devaluation has pushed up their prices and there is a demand supply gap. Many of the new projects, unfortunately are not being implemented. So, the industry continues to enjoy shortages and good profits. However, the capital cost of new plants is extremely high and is continuously rising. The outlays on new plants which are just commissioned or about to be commissioned are in the region of Rs.3500 to 4000 crores. New plants which are still being planned, will cost anywhere between Rs.5500 and 8000 crores and they involve huge foreign exchange outlays for import of capital goods. The new plants may not produce net profits for quite some time unless prices rise dramatically. Government is also worried and has proposed that foreign exchange loans to the new plants should be survived by exports. Thus, one may have a situation in which the stand alone plants may not be viable. Therefore, new plants which are parts of existing cash rich companies having high profits, will be viable. And one should be very careful in relation to investing in new plants which don't have nay linkage with cash rich streams of profits of existing companies. DYESTUFFS Future lies in exports, where competition hots up The industry has had a moderately good yea. In the domestic market, profits have been good. The fortunes of the industry linked to the textile industry. Small scale competition continues. However, the future lies in exports. Devaluation of Indian rupee is going to boost exports but competition is emerging from other developing countries. This is a mature industry with fluctuating profits. Most of the large plants are old and written off and as such have to pay taxes depressing their net profits. SODA ASH Exports picking up The soda ash industry had a good year. Even though supply exceeds demand, exports are picking up. No new entrants are announcing their intention to enter because of high capital cost. CAUSTIC SODA Cost of membrane technology soars Caustic soda has had an excellent year. demand is equal to or in excess of supply. The installation of membrane cells in some old plants is in progress. As a result of the devaluation of rupee in the two years, the cost of installing membrane technology in plants has gone more than 50%. This means that plants that have not converted to membrane technology, will now find it very expensive and very difficult to convert and they may face a grave handicap. Devaluation has opened vast export vistas for the industry and the industry has a bright future in the coming years. PHARMACEUTICALS DPCO throttling industry profits One finds that the industry has become a political football. The need to revise the Drug Price Control Order.(DPCO) which has pegged the selling prices of pharmaceuticals to uneconomic levels has become acute. More so since last year, because the costs inputs has gone up in most cases, as they are improved. Thus a pharmaceutical companies and large have shown low profits of losses in the domestic market due to DPCO not being revised. Units which are exporting are doing well, but are threatened by the change in the patent laws. Presently they are benefiting from a loophole in our patent laws, according to which product patents are not valid in India. The multinationals operating in this industry are unhappy with DPCO. Some of them have openly stated that under such adverse conditions, they are not interested in raising their equity to 51%. The demand for the industry's products is growing, but the DPCO is paralysing this industry's profits and progress. Its future, therefore depends entirely on revision of the DPCO and it is hoped that in the new free market economics which is sought to be established by the government, a favourable decision will be taken so that pharmaceutical prices are allowed to rise either under a totally decontrolled regime or a partially controlled regime. PAINTS A moderate future The industry has had good year. The excise duties have been raised in this budget to yield Rs.25 crores. The slump in the automobile sector has depressed demand and the industry has a moderate future. HEAVY ENGINEERING Exports to the fore This industry has had a good year. demand has slowed down due to industrial stagnancy. However, exports are picking up in the specialised products. AUTOMOBILES Excise burdens on a limping industry The whole industry has been slowing down and the slowdown has been especially dramatic after Oct-91. It is due to various factors as follows: Depreciation in respect of automobiles purchased after October, is half that of the full year. So purchases have tended to be bunched in the first part of the year. There has been a rise in input costs and prices. A high interest rate and the credit squeeze have tempered the demand for these products. The increase in the excise duties last year and the high petrol prices have also affected demand. Commercial vehicles have witnessed severe recession, especially in the truck segment. The two market leaders have done relatively well and are continuing to do so. New Light Commercial Vehicle producers badly hit because they import a substantial number of their components and devaluation has pushed up the prices. Despite this. The Finance Minister has levied an excise duty on LCVs and has hiked it from 10% to 15% involving a burden of Rs.50 crores on this sector which has not been doing well. This sector might now enter into a crisis situation, unless demand picks up. So far as cars are concerned, demand crashed continues to do well and he is also exporting. But the two private sector producers have really faced bad times. They are nursing huge stocks and are facing losses. They have been lobbying with the government for a cut in excise which has failed to materialise. One of the private sector producers has at last got into a collaboration with a global leader of the car industry. But production from such a venture is scheduled three years from now. Therefore, the next three years may be very difficult for the two private sector producers. As it is, production of cars is estimated to drop by 50% in relation to the past three year period. The demand for the two wheelers has gone down. Production of most units has dropped drastically owing to increased inventory. The excise duty has been slightly lowered on the two wheelers using upto 75CC. Engine capacity and has been raised in relation to the rest of the industry. In fact, the budget has imposed a slight increased the excise duties on the two-wheelers segment to yield Rs.30 crores. TYRES Cartel pricing and exports help industry The industry has had an excellent year. The budget has proposed an increase in excise duty to yield Rs.40 crores. The industry is dominated by four oligopolistic producers, who tend to work in a cartel fashion. They are able to hold up prices and even increase prices. Nevertheless, the supply is much is excess of demand, that exports have been the salvation of the industry. The industry has achieved exports of almost more than Rs.250 crores in the last year. AUTOMOBILE ANCILLARIES Replacement demand is good Surprisingly one finds that they have, by and large, had a good year. the original equipment demand ie. The demand from the vehicle manufacturers has fallen, but the replacement market has been buoyant in respect of good quality auto parts and ancillaries. And the export potential for the industry growing rapidly. BALL BEARINGS Can pass devaluation costs The industry had a good year. The cost of inputs like steel have risen sharply due to the devaluation of the rupee but the industry will be able to pass on these increased costs over the next year. some new plants which have been put up are very much but are facing teething troubles. Demand, nevertheless, exceeds supply. The industry has a good future for old top quality producers. One multinational giant has entered the industry jointly with an industrial giant. The capital cost of this venture is very high and it will take probably many years for to declare a dividend, or turn the corner. CABLES Telecommunication outlays will help jelly's Power cables have had a bad year. the demand recession due to the slow down of government spending has hit them but jelly-filled cables. ie telephone cables have done well and will do better due to higher telecommunication outlays and their rapid expansion. The import duty on copper has been raised in the budget to yield Rs.25 crores. The excise duty on wires and cables has been raised to yield Rs.60 crores. The industry depends on government orders and has cost escalation clauses which enables it to pass on these new levies. The demand of this industry is substantially in excess of supply and this is expected to continue. Therefore the steel industry has a bright future, atleast for the next two to three years. MINI STEEL Next year to be better The industry had a difficult year as its raw material, scrap, is imported and is inadequately available even at high prices. Similarly, sponge iron prices are squeezing the margins of the mini steel industry. The shortage of scrap is protected to ease in the near future with availability of foreign exchange. As a result, sponge iron prices have also softened from the peak levels. Next year should be better for the mini steel industry, especially for those units producing high value products. SPONGE IRON Convertibility would buoy up sponge Sponge iron units have prospered due to scarcity of scrap and the prices of sponge iron were raised to almost Rs.5000 pert tonne. But now, prices of sponge iron have started going down because of the better availability of scrap. 1992-93 will be a good year for the sponge iron industry, as partial convertibility would increase the cost of imported scrap and sponge iron prices perhaps may rise by Rs.300 to Rs.400 per tonne. The Finance Minister has increased the custom duties on many iron and steel items to yield a net revenue of somewhere in the region of Rs.160 crores. As the industry is now decontrolled, prices are expected to rise after April. These duties would be passed on to the consumers and will not affect the profitability of the industry. Aluminium Devaluation aids exports The aluminium industry is doing well and the devaluation of rupee has helped. Even though supply has effected substantial exports. Power constitutes an important cost of production and the market leader has been benefited because of having a captive power plant. No new large capacities have been planned and the profits of the existing producers should remain well protected. COTTON TEXTILE Yarn spinners do well; integrated mills flounder The cotton textile industry had a very good first half year, but there was a dramatic crash in profitability after Dec-91, because cotton prices shot up by over 75%, and the prices of the finished products could not reach anywhere near the increase in the raw material prices. Most of the integrated units have started losing money since Oct-91 and the results of the second half will show a sharp downward trend in profits of the cotton textile industry. The yearn units are also adversely affected but not as much as the integrated units. Yarn producers profits have dropped in the second half due to the flare in cotton prices, but they are still in a better position than integrated mills because they sell to the decentralised sector and are also exporting at fairly lucrative prices. Exports to the former Soviet Union have dried up ELECTRICAL & ELECTRONIC CONSUMER DURABLES Competition and devaluation curtail profits Severe competition continues in this sector. There is a demand recession due to tight money and high interest rates. Television, radios, videos etc are in depressed markets. Devaluation has pushed up the cost of the inputs which are largely imported. But some items offering the latest technology and quality products are doing well. Some new items have come in, like microwave ovens, washing machines etc, which may have niche markets. So far as the computer industry is concerned, the industry has been hit by devaluation of the rupee because it depends largely on imported components for its production. Small companies are hit by fierce competition from global giants. A number of global giants have entered the field and their sales are growing. The profits in computer hardware are fairly low because of competition. Software development and exports still offer good scope for large units linked with global giants. AIR CONDITIONERS AND REFRIGERATORS New technology coming The industry is very competitive. There is a demand recession due to high prices and tight money conditions. Technological change is occurring here. Thus, no frost or frost-free refrigerators and new types of air conditioners with latest silent, and energy efficient compressors are about to be launched. PAPER Sings of inventory accumulation The industry has had a good year. it has raised prices. But imported raw material which constitute 25% of total raw material, are costing more because of devaluation. In recent weeks, demand has been softening. There are signs of inventory accumulation and prices could soften. HOTELS Share prices too high Last year's occupancy rates were poor. But the devaluation of the rupee and the partial convertibility, may result in a rise in foreign exchange earnings of these hotels. But the share prices of hotel companies have shot up to very high, almost unrealistic levels, which make them unattractive. TEA AND COFFEE Russian exports to pick up Tea has had a good year even though the Russia market has slackened. But trade with Russia will resume, exports are spurred by devaluation and domestic is growing quite rapidly. Coffee has had a bad year but could improve later on. FOOD PROCESSING INDUSTRY Profits may double every three years The food industry has had a bumper year. the leading companies, linked with global giants, have had excellent growth in their sales and will show dramatic increase in profits. Demand for top quality products is growing at a sizzling rate of between 25- 30% per annum and margins are holding up. In the case of top quality food companies, profits may double every three years, which may justify high P/E ratios. The industry is also favorite of the government, which has a separate ministry to look after it and therefore it has strong growth ahead. But in this industry do not invest in small poorly managed companies having no brand leadership. There are a few companies which are managed well, which are run by global giants and which will show spectacular results in the next three years. CIGARETTES Share prices puffed up Cigarettes have had a good year. the budget has increased the excise duty them. He burden of excise duty is Rs.325 crores. The excise duty will be based on the consumers. The industry is dominated by affiliates of global giants __ diversifying, just as the tobacco industry is doing in all parts of the world into other lines like hotel and foods. It still has excellent export growth potential. Share prices of companies in this industry have exploded to levels at which one must question whether they offer value. SHIPPING Long term outlook cloudy Profits will increase due to the partial convertibility of the Rupee. Shipping companies were not getting the Exim scrips in the earlier period and to the extent that 60% of their foreign exchange earnings will now be saleable they will benefit. But a warning; the shipping freight rates have started softening. The Baltic Freight Index which had jumped to almost 1,700 has been slowly sliding down and is now approaching 1200. Therefore, the long term future, is somewhere what cloudy. May be we are the top of the shipping cycle. Profits in this industry have often been made more by buying and selling ships than in running them! So please be careful before buying shares in this industry. Watch the Balance Freight Index. Part 3: Long Term Investment Strategy……………… BUYING PANIC ON INDIAN STOCK MARKETS A detailed analysis of the stock market action is required to understand what has happened in the light of the budget presented in Jul-91. On Jan2, 91, the BSE Sensitive Index (hereafter called sensex) closed around 1000. Then between Jan. and Jun,91 it saw a low of 947 and a high of 1344. In Jul.'91, the sensex fluctuated between 1679 and 1251. The Sensex in pre-budget session stood at 1459 in Jul.91. after the budget it was 1600. Thereafter, between Aug-Dec,'91,an interesting pattern emerged ,as the Sensex tried to cross the 2000 mark. In Sep.'91 it rose to a high of 1981. In November to 1995 and in December to all three times. The low during these months was 1598. It had taken the Sensex twelve months to try and climb from 1000 to a little below 2000. In the year 1992, the Sensex fluctuated between 1973 and 1960 on2 Jan.'92, Again for the first two weeks of January, the Sensex struggled to break this barrier. Then, from 16 Jan.'92, there was a straight run from 2024 to 2329 on 31 Jan.'92, thus establishing a breakout. More interesting, from 1 Feb to the pre-budget session of the stock market, the Sensex soared from 2329 to 2830. The Sensex in the post budget session rose to 3017 and further in tow days it jumped to 3472. This indicates a jump of 500 points (from 2830 to 3472) in three sessions of the stock market. This, is in technical language, known as buying panic. It has occurred rarely in other parts of the world. Buying panic means that in three or four days the index jumps perpendicularly, as everybody including the institutions are paralysed because everyone wants to buy and no one want to sell. It is for the first time in the history of the BSE that a buying panic of this magnitude has occurred. The price earnings ratio, as published by the BSE journal in Jan.'91.was around sixteen. InJul.'91 it varied from twenty-one to twenty-five by Jan.'92. At the pre- budget session it was between thirty four and thirty six. In the last four days succeeding the budget, the ratio jumped to a level of forty-one to forty-four. This shows that irrespective of the rise in profits, the P/E ratio also jumped wildly. Another indicator that should be mentioned is the price to the book value of the shares. It is now more than seven times. Further, dividend yield has fallen to less than 1%. This shows that, in relation to the historical worth of shares, the prices have jumped to absurd levels. Seven times book value is no level at which a market should trade. Now, does his conclusively mean that the market is highly- over-budget? For long, it was thought that only the fundamentals influence the stock market pricing. Recent research shows that the prices are determined by three factors. The first factor is fundamental and has a 40% weightage. The second is the demand-supply equation for shares which determines the market prices to the extent of another 40%. And the third factor, called the X-factor, determines the remaining 20%. The X-factor reflects the psychology of investors and their attitude towards investment in shares. The normal P/E ratio for India, is prevalent in many parts of the world, to give value to the investor and fundamentalist, should be between fifteen and twenty times the earnings. Normal prices to book values should be between one and two-and-a- half times the book value. Changes in Government policy, especially the shift from the socially controlled economic pattern to a free market policy, cannot justify the extremely high ratios on a fundamental basis. It is true that in some countries the P/E ratios are high. In Japan and in Taiwan it is supposed to be between thirty-eight and forty. In Indonesia, prices rose steeply after liberalisation, but they experienced an equally steep fall. The net profits of the industries would have to jump by 100-300% to justify these ratios. This is unlikely in the coming two or three years. Therefore the prices are over-optimistic and discount the profit scenario perhaps as has upto 1995, which is unhealthy involves a very heavy risk. Let us now consider the technical demand position in the market. It should be given a 40% weightage. Under the demand-supply scenario stated in the following table. Guidelines have been issued by SEBI for the formation of private sector. Mutual funds. They have been put on a level playing ground with public sector Mutual Funds. This is a welcome measure. There is a terrific rush to enter this sector------ somewhere between eight_ hundred applications have been filed in SEBI to enter the mutual fund industry. SEBI should very carefully examine these applications and ensure that the desirable or inexperienced individuals must enter the private mutual fund industry as that will mar the reputation of the industry. As also its future growth. Nevertheless competition will emerge in this field but, the entry of private or joint sector mutual funds (when they come) will be good for mobilising an additional flow of funds into the market. This flow is estimated at Rs.6000 crores in the table above. The budget has been called 'golden' by NRIs. They are allowed to legally import gold after paying an import duty of Rs.45 per ten Gujarat Ambuja and they ca import gold upto five kg. They are further allowed to purchase property and shares under FERA. This is good for the stock market. A red carpet treatment given to NRIs is bound to result in the flow of their funds into the markets, estimated at Rs.2000 crores. The India Development Bonds and other schemes have mobilised around Rs.5000 crores. And investor response to the primary market may be around Rs.10000 crores. Thus total demand for shares will stand around Rs.23000 crores. The Finance Minister has said that the government control over capital issues is proposed to be removed as also the premium fixation. The premium are to be determined not only by market forces, but also, by the attitudes of merchant bankers, and company managements. Therefore, we have a competitive situation which is welcome. This will increase he liquidity of the new issue market, which will grow rapidly from last year's figures of Rs.6500 crores around Rs.1200 crores. The Finance Minister has sold Rs.2500 crores worth PSU shares in packets to mutual funds, TUI,LIC and the public sector banks. Their listing might result in the slaughter of thousands of investors. It is absolutely essential that all the relevant data about a listed PSU (its past and present) should be made available to the investor. In short, all the details that a private sector company is forced to give, reveal and make public, through a prospectus, should also be given by the PSUs (atleast in an abridged form). Only then can the investor gauge whether the prices at which the shares are offloaded (by the mutual funds) to them is fair. Though some PSU are claiming to have got listed at the Delhi and Jaipur Stock Exchanges, not a shred of information is available on them there. All PSUs which get listed at BSE should be treated on par with other companies and all the rules of listing should apply to them. It is also desirable that the mutual funds should start disinvesting the PSU shares (Which they have got at cheap prices) at market rates. Provided one assumes that around Rs.6000 crores worth of PSU shares would thus flow in, and along with other mutual fund sales of Rs.3000 crores and investor sales of Rs.2000 crores, one arrives at a supply figure of Rs.23000 crores. Thus we arrive at a supply-demand equation of Rs.23000 crores. This is under the assumption that there will be an even flow of new issues over the months. But if in case, new issues are delayed by say six months, due to indecision or lack of CCI, demand for shares resulting in a flare up in prices. Similarly, there should not be a delay or absence of disinvestment of PSU shares by the mutual funds. If all goes well, one may get an evening out of the demand and supply in shares in which case the markets may not get overheated. The X-factor, which is the third factor, is the psychology of demand. Just now the public euphoria is tremendous. New government policies are making everybody see a rosy future. The budget and the government statements encourage people to rush into shares. But nay setback could make this bull run come to a stop. The public, in event of setback, a drought or some other cause will turn away from the market. RECOMMENDATIONS TO INVESTORS In my earlier lectures I had given several points for selection of quality shares and those points are still valid. I now add some further points for investment strategy in the coming year: There is a great risk in the market now. Please adopt a very cautious approach. Begin to sell over-valued stocks where huge profits have accrued. Raise cash to 30% of the value of the portfolio. Sell upto 30-50% of the individual portfolio. Failure of monsoon or drought will lead to a crisis. Buy shares very cautiously. Give top priority to FERA shares. This is because the flow of funds from foreign mutual funds will tend to be invested in such companies. Also the FERA Act has been amended to give such companies freedom to expand. But property and use international brand names. These are very great advantages. Avoid issues of small companies having unkown managements. Avoid issues of finance companies run by people with no track record. Avoid units of mutual funds launched by managers without a past track record. Watch the macro factors operating in the economy and take a long-term view of them while buying shares. What goes up very fats falls down at a faster rate. Be very careful while buying PSU shares. Get all the past data. The PSU will be privatised only to the extent of 49% as per present announcements. Government plans to hold on to 51%, even over the long term. Therefore the management won't change overnight. Concentrate on shares with high credit ratings, by utilising the ratings of the credit rating companies. Avoid companies with high debt, especially debt in foreign currency loan as devaluation will hit the harder in terms of repayment. Do not rely on tips. Buy shares after doing own research. Sell shares where the P/E ratio is more than 100, unless profits are expected to jump up quickly by 400 to 500% due to some special or abnormal factors. Do not be fooled by replacement value theories to justify high share prices. Be careful of the turnaround situations. The idea that yesterday's failure of sick companies is definitely tomorrow's success is an unsound idea. There are many sick companies that don't turn around. There are some investors who believe that if there are any shares that are trading below par, they should be bought because at sometime they must turn around. No such thing may happen. Do not invest on the greater fool theory. In bull markets, investors knowingly buy a share at a very high price, expecting to find a greater fool who will buy it at still higher price. This is a very unsound method of thinking. Do not follow so called model strategies on investments which recently have started circulating and which are written by theoreticians who have not any idea or experience of the stock market. It is difficult to predict the market movement of one year ahead. So do not believe in theories predicting market trends into future decades. In volatile markets timing is critical. Be much more active in such a market. Watch political developments in relation to the market. Watch the badla rates and the technical position of the market and the trends into future decades, Be alert in cutting losses and booking profits. Do not attempt to sell at her very top price and buy at the lowest price-----------that is impossible in the long term.
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