Q3-2018

Most economists concur that external factors are largely responsible for the Rupee depreciation. Tightening of US monetary policy and the threat of global trade protectionism have created a flight to safety for capital, which has impacted emerging markets. From the Rupee’s perspective a vicious cycle has ensued –investors have pulled capital out of India which has placed downward pressure on the exchange rate, and consequently triggered additional selling by foreign investors. Since the start of 2018, foreign institutional investors have pulled out close to $2 billion

Inflationary risks from an uneven distribution of monsoon rains and a rise in minimum support prices for crops, along with a depreciating rupee and the narrowing interest rate differential have led the monetary policy committee (MPC) of the Reserve Bank of India (RBI) to increase the benchmark rate in two consecutive meetings, after a steady reduction over the last three years.   

The banking sector is yet to emerge from the bad debt crisis, which hampered credit growth over the last few years. A new liquidity crisis has emerged for other shadow financial institutions (NBFCs) due to an asset-liability mismatch.

IL&FS, a leading Indian infrastructure development and finance company has defaulted on its obligations multiple times in the last couple of months. Widely considered to be a quasi-government entity with a AAA rating, short term paper issued by IL&FS was widely held across insurance companies and mutual fund houses.  With combined debt across its subsidiaries of over Rs. 910 billion (US$12 billion), the fear of a domino effect from further defaults triggered a sell-off in equity markets in September particularly for NBFCs. The hardest hit have been housing finance, infrastructure finance and wholesale financing companies. 

In a move to restore investor confidence and stem the contagion in the equity and debt markets, the government has stepped in to replace the IL&FS Board with a six-member panel led by Uday Kotak – a highly successful banker who has built a strong reputation for effective risk management.

To infuse liquidity into the system, the RBI has also announced that it would inject Rs. 360 billion (US $5 billion) via bond purchases in October. This follows a similar infusion in September and a relaxation of liquidity coverage ratios to ensure sufficient levels of currency in circulation during the upcoming festive season. 

The ability of the government and the RBI to intervene and arrest negative developments comes from the platform of strong macroeconomic fundamentals in India. As mentioned earlier, growth remains robust. The government remains committed to fiscal prudence and the foreign exchange reserves held by the Central Bank remain at a very healthy level (over $400 billion), serving as a buffer against any external shocks. Consumer spending (as evidenced by same store sales growth and vehicle purchases) is growing; demand for retail loans is high and industrial production is also recovering after a lull. In its recent Global Macro outlook , Moody’s remains optimistic about India’s growth given the support extended by strong urban and rural demand and improvement in industrial capacity utilization.

This is also a period of uncertainty – both at the political and corporate levels.
There are leadership changes occurring at a number of private sector banks in India.  ICICI Bank, Axis Bank, and Yes Bank are all in the midst of CEO transitions – with most of the departures being dictated by the RBI. The deputy CEO at HDFC Bank has also quit, putting succession planning into high gear. Unprecedented leadership changes happening at the same time when the financial system is recovering from the largest NPA crisis and reacting to the IL&FS crisis has impacted the equity markets. We have held the belief that valuations in India have far outpaced earnings growth over the past few years.  This current macroeconomic situation may lead to potential investment opportunities at sensible valuations for investors.
 
Election uncertainty is likely to impact markets and investor sentiment in coming months. In the 2014 elections, the BJP won a comfortable majority in the 572-seat lower house of parliament. Prior to that election, the BJP controlled the state governments of 7 out of the 29 states. Currently, the BJP or its alliance partners run the state governments in 19 Indian states, which represent close to the two-thirds of the country’s population – a much broader electoral support base, which if converted, could lead to continuity of the reform agenda that the government has initiated. 

However, recent losses in the Karnataka state election and the collapse of alliances in Jammu & Kashmir and Andhra Pradesh have been political set-backs and suggest that the outcome for the 2019 general election is far from certain. Results of three upcoming state elections where the BJP is the incumbent will serve as a barometer of public sentiment going into the general elections. 
 
The next chapter of the Indian growth story promises to remain interesting. 

The importance of setting culture through role modeling

Instilling a strong culture means having a core set of values that the organization believes in and lives by on a daily basis. However, all too often these values get lost between the lines of a lofty mission statement, which itself is confined to a plaque on a wall somewhere in the hallways of the office.

Actions, we all know, speak much louder than words and for a desired culture to reflect across the organization, leaders need to be proactive and authentic in demonstrating the very values that they wish to see cultivated. In the absence of clear behavior from leadership, which is consistent with desired attributes, there can be “cultural silos” within the organization – making it misaligned at best and divisive at worst.

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