Infosys surge: another miss for analysts

Infosys surged past Rs 3000 yesterday and has fallen back a bit today. I have no expertise on the IT sector. However, having been in investment banking, I do note with interest- though not with surprise- that analysts completely missed the turnaround in the stock's fortunes.

The big shocker to the analyst community was the favourable revenue guidance given by the company during the last quarter results. That caused analysts, who were predicting a stock price of around Rs 2200 or below in the months ahead, to revise the stock price target upwards. Even then, the higher targets were only around Rs 2850. Some analysts insisted they would wait for another quarter to see if the improvement was sustainable. Then, there was a whole tribe of analysts and media commentators who were telling us that the problem lay with the wrong choice of CEO to succeed Kris Gopalakrishnan, that the exit of most of the founders had changed the company culture completely, etc. So, the stock surging past Rs 3000 is quite a miss for the analyst community.

Of course, in these situations, hindsight is always available. ET, quoting various experts, gives reasons for the stock's improved performance. But the question is worth asking: if analysts can't get it right with a company so visible and so closely tracked as Infosys, what are they there for?

Fresh bout of disinvestment

Hopefully, we should soon see a fresh bout of disinvestment, with several unlisted PSUs being brought to the market. That's very good news. Not because it will help contain the fiscal deficit, as some commentators have rushed to point out. The fiscal impact of disinvestment tends to be exaggerated. Its real value lies in its potential to bring about greater commercial discipline through listing on the stock exchange.

Disinvestment helps improve performance when combined with competition and better board room governance. Liberalisation has taken care of competition. More needs to be done on board-room governance in PSUs. Unlike in the private sector, there is scope for doing a great deal more, as I argue in my ET column, Disinvest for better governance.

Pranab Mukherjee's budget

The market tanked yesterday. I wasn't surprised at all and had forecast a correction in my ET column a fortnight ago, Market rally may prove deceptive.

I based my assessment on two things. One, the $ 5 bn plus FII inflows in the present financial year represented something of a correction to the huge outflow of $11 bn last year. We could not expect this sort of inflow to continue. Secondly, I, for one, have never bought the notion that the Congress or the present UPA is hugely reformist is orientation and that all that it needed to get into reform mode was shake off the Left. Sonia Gandhi retains the leftward leanings of the family and this is duly reflected in the Congress today.

So, I had a few quiet laughs when I saw the commentators and businessmen on TV shake their heads in sadness at the many missing items- fiscal consolidation or even a medium term plan for one, disinvestment, petroleum deregulation, impetus to FDI, labour market reforms, financial sector reform (the Raghuram Rajan report was not even mentioned in passing).

I must mention one distinguished exception to the nay-sayers: Surjit Bhalla, whom one would regard as ultra-reformist. I did a double take reading his piece in BS today. He hails this as the second most reformist budget ever presented after Yashwant Sinha's 1999 budget. I read his piece again thinking this was being said tongue- in- cheek. No, Bhalla is serious. Well, leaving aside the critics on TV, I doubt that that is a claim that even the FM or the Congress would make!

What do I make of the budget? Well, I am yet to put the numbers on a spread sheet and pore over them (which is what I do once the media frenzy dies down). I have just a couple of thoughts for now. One, the budget is true to the Congress manifesto and the broad indications given in the President's speech.

Two, the focus is on providing the maximum fiscal stimulus. This probably reflects the government's view that the 'green shoots' hypothesis is premature, that the global economy will take its own time recovering and that, therefore, the Indian economy's growth momentum is best sustained through as big a stimulus as possible. People fear that this will push up interest rates and crowd out private investment. But private demand for credit is weak, which is why there is huge liquidity out there in the markets, so this fear may prove misplaced.

Three, my guess is that the FM has left the possibility for greater disinvestment proceeds than budgeted and spectrum auction for later in the year. To do this now would detract from the stimulus. So, give the maximum stimulus now and once there are signs that growth is of the order of 7%, push ahead with disinvestment. If this hypothesis turns out to be right, the FM may well surprise us with the fiscal deficit number in his next budget- it could prove lower than 6.8%.

Now, this is not how economists and market analysts view matters. They would have liked some fiscal consolidation here and now and they probably reckon that economic recovery is happening anyway. Unlike most of the intelligentsia (which is not necessarily very intelligent), I have great respect for the instincts of politicians, so I would go along with the FM. If the FM's calculations prove right, it would be quite an achievement.

Anatomy of a witchhunt

In March 2001, the BJP government presented what many regarded as the real "dream" budget- I remember one industry spokesman ecstatically giving it a perfect score of 10. Unfortunately, the stock market did not think so. It tanked.

Hell hath no fury like finance ministry scorned. It was convinced that the market fall was engineered and it was determined to find out who was behind it. Ten days later the Tehelka corruption expose emerged and it turned out that one of the journal's promoters, Shankar Sharma of First Global Stockbroking, had short positions in the stock market.

The law enforcement agencies descended on Sharma. He was arrested and jailed for a long period without any charges being established against him. In September 2002, Sebi cancelled Sharma's stockbroking license. Eventually, Sharma was acquitted of all charges. Sebi's order was set aside by the Securities Appellate Tribunal in 2004.

There was much scepticism about the charges against Sharma even then. Sharma recently used the RTI to obtain the trading data for the relevant period. It turns out that First Global was not even among the top 50 short sellers ! Business Standard has strong words on the way the Sebi conducted itself:

It has long been suspected that the cases against Mr Sharma and his company were not a result of wrongdoing on their part, but as punishment for having been involved with Tehelka. The fact that the cases were dismissed (one on technical grounds) supports this view of what happened. Further evidence to buttress this view has now been produced by Mr Sharma, suggesting that the stock market regulator had no reason to suspect the activities of First Global in the first place. Using the Right to Information law, Mr Sharma has obtained the trading data maintained by Sebi for the period in question. These data show that First Global does not even figure in the list of 50 largest sellers, from the middle of February to the middle of March 2001. That raises the question as to why this data was ignored by Sebi before it passed orders against First Global. Indeed, the prosecution lawyer was so unhappy with the case being made out that he withdrew from the case, in itself a telling comment.

If so, several questions arise. On what grounds did Sebi take action against First Global? Why do the concerned people show reluctance to address the issues that have been raised? Sebi’s continued silence on this matter will only undermine its standing as an independent regulator that acts without being influenced by the government’s political motives. Cases of state vendetta against individuals are not unknown, but this is the first case where the political authority seems to have influenced stock market regulators. Is it coincidental that First Global received Sebi’s adverse verdict during the tenure of the Vajpayee government? And that the appellate tribunal set aside that Sebi order a few months after the Vajpayee government completed its tenure?

Gujarat government charity schme fails at GACL

ET today reported that the proposed move to use 30% of pre-tax profit at PSUs in Gujarat has failed to get the shareholders' nod at GACL. The proposal required approval of three-fourths of shareholders. The proposal failed to muster the necessary votes at GACL thanks mainly to opposition from institutional shareholders.

There has been criticism of the charity move on the ground that it is inimical to the interests of non-government shareholders. But the state PSUs hardly have the profile of a Satyam, so the coverage of the issue has been rather small.

Explaining the Indian stock market's fall

Business Standard carries a report on how margin requirements contributed to the steep fall in the Indian stock market earlier this week:

According to stock brokers, the real pain in markets started with the over-zealousness on the part of stock exchanges in collecting margin money after the 700 points fall on January 18 and another 14,00 points fall on January 21.

The trading terminals of nearly 90 per cent stock brokers were shut on Tuesday when the markets hit the lower circuit of 10 per cent within a few minutes of opening bell, as the National Stock Exchange doubled the margin money overnight.

"The exchanges wanted stock brokers to pay additional margin money immediately. How can we do this when our clients' cheques take at least two days to clear?" asked a Bombay-based broker who deposited an overdue margin of about Rs 1,000 crore (Rs 10 billion) with the exchanges on Wednesday.

A payment crisis was already looming in the aftermath of the Reliance [Get Quote] Power IPO.

The call for more margin money, from stock exchanges, had a domino effect on the markets.

How far is this explanation valid? Well, increased margin requirements for brokers at a time of falling markets are always a reason for the sharpness of market declines. But, it is not as if the problem will go away if the cheque settlement system is improved.

That's because many of the investors who get into payment difficulties are those who have borrowed in order to speculate in the market. They borrow for day-trading, for IPOs and for any other investment in the stock market. They will have to sell their shares any way in order to meet margin calls. Whether the shares are sold by the brokers on whom margin demands are made or by the investors makes no difference- there will be huge sales and there will be overshooting in the market.

Theoretically, banks can provide finance to investors but they will be wary of lending when markets are in a state of free wall. As the BS report mentions elsewhere, there has to be some proportionality between margin payments made by investors and their brokers- the less stringent the margin requirement, the greater are the chances of a decline in the stock market escalating into a crash.

Restrictions on capital flows- Sebi proposals

Not to sound boastful but I wasn't perturbed at all when I learnt this morning that trading had been halted after a steep fall in stock prices triggered the circuit breaker. I was awaiting "clarifications" from official sources that would calm the markets. That's exactly what happened. After the PM and the SEBI chairman came on the air, the market recovered to end the day around 400 points lower- a considerable recovery from the fall of 1700 points earlier.

The draft regulations circulated by Sebi, which will become law with or without some minor modifications by October 20, are intended to curb capital inflows into the country. It will do so by curbing the volume of Overseas Derivative Instruments (Participatory Notes), instruments through which foreign investors can invest in India even if they are not registered as Foreign Institutional Investors.

PNs constituted 51.6% of Assets under Custody (AUC) in August 2007, 30% of which had derivatives as the underlying. The RBI has long been in favour of phasing out PNs but the finance ministry was resisting because it didn't want the stock market run to stop. With the kind of rise in the Sensex we have seen in recent weeks, the ministry, no doubt, reckons that a correction is affordable.

Sebi's proposals are as follows:

1) FIIs and their sub-accounts shall not issue/renew ODIs with underlying as derivatives with immediate effect. They are required to wind up the current position over 18 months, during which period SEBI will review the position from time to time.
2) Further issuance of ODIs by the sub-accounts of FIIs will be discontinued with immediate effect. They will be required to wind up the current position over 18 months, during which period SEBI will review the position from time to time.
3) The FIIs who are currently issuing ODIs with notional value of PNs outstanding (excluding derivatives) as a percentage of their AUC in India of less than 40% shall be allowed to issue further ODIs only at the incremental rate of 5% of their AUC in India.
4) Those FIIs with notional value of PNs outstanding (excluding derivatives) as a percentage of their AUC in India of more than 40% shall issue PNs only against cancellation / redemption / closing out of the existing PNs of at least equivalent amount.

So, the idea clearly is to limit investment in the Indian market through PNs. There has always been a problem about the identity of investors holdings PNs. For that reason alone, restrictions on PNs are welcome. But will it help meet the objective of curbing capital inflows? In the short run, yes. In the long run, no, for the simple reason that the volumes waiting to enter India are enormous. Once PNs are barred, we should see an increase in those wanting to register as FIIs.

I am sure the finance ministry and Sebi recognise this. But a breather on the capital inflows is welcome- and the present proposals will provide just that. JP Morgan estimates that the ouflows on account of the unwinding of PNs with derivatives as underlying could be $4-7 bn; the unwinding on account of PNs issued by sub-accounts of FIIs will be even larger. Of course, all this will happen over a 18 month time horizon although it may not be evenly spaced out over that period.

Forex additions this year have been $50 bn- the addition considered comfortable was around $25 bn. In relation to overall capital inflows, the outflows that will be triggered by the Sebi move
will be a minor speed-breaker. International factors remaining the same, it will slow the rise in the Sensex over the next few months. But it does provide some breathing space for RBI in terms of managing the exchange rate- the way things were going, it appeared the rupee would soon touch Rs 35 to the dollar.

In macroeconomic terms, the Sebi move does not amount to much over the long term. It does little to alter the trend towards rupee appreciation. But, as I said, it gives a little time for adjustment to appreciation- and that is exactly what Indian industry needs and can expect at best. Rupee appreciation can be managed, not eliminated.

The combination of a rising stock market and rupee appreciation would have meant capital inflows on an uncontrollable scale. That would have had a severe impact on the Indian economy. The speed-breaker imposed by Sebi is good for the economy. It is also good for the stock market. I think the market will recognise this - and continue its climb.

Awash in liquidity

The rise in the Sensex beats anything we have experienced in the recent past. I mean, we are supposed to be in the midst of a serious international financial maket crisis. Some think the probability of a US recesssion is still pretty high and that global economic growth will be dragged down in consequence.

If the Sensex has taken note of these, it's not showing. For some reason, funds continue to pour in. The statistics I saw on TV are: FII inflows of $1 bn in the past week, net inflows of $ 3 bn in September. And the best annual score thus far has been around $10 bn!

Deepak Parekh was on one of the channels a couple of days ago. He suggests that whole new classes of investors are waking up to India: US insurance and pension fund investors (as distinct from mutual funds and hedge funds, thus far the prominent US investors in India), Japanese retail investors, the newly set up sovereign wealth funds. Then, you have huge oil surpluses looking for alternatives to US and Europe. A tiny percentage allocation to India turns out to be a flood so far as we are concerned.

The biggest surprise to me is the rebound in IT stocks. I thought they were headed relentlessly southwards in the wake of an appreciating rupee. But, this week, the stocks are up again. I asked a street corner broker whether he had an explanation. He said Infosys' Nandan Nilekani had indicated on TV from New York that Infosys was in a position to weather the impact of the rising rupee. That did the trick this week. Whether this will last we will know when the first quarter results start pouring in from October 5.

Where's the Sensex headed?

Citigroup unveils its forecast (ET, March 15):

Announcing their target values, Citigroup’s regional equity strategist, Markus Rosgen, has set a target of 14700 to 16000 for the Sensex as of December 2007.

This is based on a fair value of 13300 for Sensex and 10-20% premium on account of higher ROE’s(return on equity) and expected upgrade momentum for earnings estimates.

......Citigroup expects earnings growth of its Indian universe at around 15-20% and expects growth rates to trend downwards from current cyclical peak of around 25%

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Err.... could we have Citigroup's forecasts for the past three years?