strategy - reliance mutual fund have a conflict of interest that could affect the objectivity of...
TRANSCRIPT
Ambit Capital and or its affiliates do and seek to do business including investment banking with companies covered in its research reports As a result investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report Investors should not consider this report as the only factor in making their investment decision
Can lsquovaluersquo investors make money in India
In this note we address the age-old debate on lsquovaluersquo vs lsquoqualityrsquo Whilst lsquovaluersquo delivers over shorter time frames (a year or less) the value premium tends towards zero over longer time frames say 10 years This is because whilst valuations dominate short-term performance earnings growth dominates over longer time frames Earnings growth in turn is the weakest for the cheapest stocks Further value and quality are not mutually exclusive we highlight a few high-quality companies trading at reasonable valuations from our Coffee Can Portfolio (CCP) and ten-bagger portfolios
The value vs quality debate Our investment approach centers on investing in quality businesses for the long term our Ten-bagger and Coffee Can portfolios are both modeled on this philosophy Further we have tilted towards being agnostic to valuations in these portfolios as we believe that after screening for quality adding a further valuation filter does not enhance performance Yet at the same time the existence of a value premium has been well documented especially in the Western context In this note we address this disconnect between the two approaches value and quality Value delivers over shorter time frames of around a yearhellip Analysing the performance of quintiles based on PE suggests that low PE works well thus supporting the existence of value premium The performance of lsquovaluersquo is best over a one-year holding horizon and the premium dissipates as the holding horizons increase Moreover earnings growth remains weak for the cheaper quintiles suggesting that it is a rerating in valuation multiples that drives the near-term outperformance for lsquovaluersquo stocks hellipand the value premium dissipates over longer-term horizons The link between beginning period valuations and stock returns becomes weaker over long time frames and approaches zero on a ten-year basis Thus whilst valuations play an important role in driving stock returns in the near term in the long run it is the underlying trajectory of fundamentals that drives returns with valuations tending towards irrelevance Thus lsquovaluersquo stocks with poor earnings growth do not deliver over longer holding horizons However value and quality are not mutually exclusive Stocks become expensive for several reasons such as investors betting on a revival Similarly good companies may go out of favour due to near-term concerns and may become cheap Thus quality and value should not be seen as mutually exclusive groups In fact a distribution of firms with RoCEs of gt15 suggests that such firms are uniformly distributed across PE quintiles (like the distribution of our Ten-bagger and Coffee Can firms too) Combining value and quality on the other hand should thus improve returns further
THEMATIC April 29 2015
Strategy
High-quality companies from our model portfolios trading at reasonable valuations
Ticker Company name
Trailing PE
Part of which portfolio
TCS IN TCS 245 Ten-baggers
ITC IN ITC 286 Coffee-can Ten-baggers
HDFCB IN HDFC Bank 240 Coffee-can
COAL IN Coal India 174 Ten-baggers
TTMT IN Tata Motors 103 Ten-baggers
HCLT IN HCL Tech 172 Coffee-can Ten-baggers
AXSB IN Axis Bank 181 Coffee-can
IDEA IN Idea Cellular 226 Ten-baggers
TRP IN Torrent Pharma 238 Ten-baggers
MRF IN MRF 141 Ten-baggers
MTCL IN Mindtree 194 Ten-baggers
IPCA IN Ipca Labs 217 Coffee-can Ten-baggers
BIL IN Balkrishna Inds 151 Coffee-can
CUBK IN City Union Bank 131 Coffee-can
PSYS IN Persistent Sys 191 Ten-baggers
ECLX IN eClerx Services 198
Coffee-can Ten-baggers
FNXC IN Finolex Cables
193 Ten-baggers
SF IN Sundram Fasten
272 Ten-baggers
GDPL IN Gateway Distr
222 Ten-baggers
VST IN VST Inds 173 Ten-baggers
MUNI IN Mayur Uniquoters
224
Coffee-can
Source Bloomberg Ambit Capital research Note These are stocks from our model ten-baggers and Coffee Can portfolios that fall in Q3 Q4 or Q5 on trailing PE
Analyst Details
Gaurav Mehta CFA +91 22 3043 3255
gauravmehtaambitcapitalcom
Karan Khanna
+91 22 3043 3251
karankhannaambitcapitalcom
The lsquovalue premiumrsquo dissipates in India as holding horizons increase
Source Company Ambit Capital research Note Value premium is the excess returns for the cheapest quintile on trailing PE vs the average returns for the remaining four quintiles
-60
-40
-20
00
20
40
60
1-yr 2-yr 3-yr 4-yr 5-yr 10-yr
Value premium
Strategy
April 29 2015 Ambit Capital Pvt Ltd Page 4
lsquoValuersquo vs lsquoqualityrsquo The debate on what matters more value or quality has always been a hotly contested one and has gained more prominence recently given the sharp share price correction in many of the expensive good-quality names
Our preferred investment approach traditionally has been to invest in Good amp Clean companies which implies investing in firms with high corporate governance standards and an efficient capital allocation track record Our Coffee Can and ten-bagger portfolios have been modeled on this approach (click here for our 17 November 2014 note on the ldquoCoffee Can Portfoliordquo and here for our 5 January 2015 note on ldquoTenbaggers 40rdquo) In creating these portfolios we have been agnostic to valuations as beginning period valuations do not stay as relevant in shaping long-term returns after having been already screened for quality
In our 20 November 2014 note ldquoRole of valuations in long-term investment successrdquo we had shown that the five Coffee Can portfolios from 2000 to 2004 had gone on to beat the Sensex over the subsequent ten years in spite of higher beginning PEs
Exhibit 1 Coffee Can portfolios beat the Sensex in spite of higher beginning period valuations CAGR returns for ten-year period startinghellip
CCP All-cap returns
Sensex returns
Beginning-period Sensex PE
Beginning-period CCP PE
30 June 2000 ndash 30 June 2010 167 141 227 318
29 June 2001 ndash 30 June 2011 217 185 169 201
28 June 2002 ndash 29 June 2012 190 183 142 160
30 June 2003 ndash 28 June 2013 251 183 117 129
30 June 2004 ndash 30 June 2014 316 181 125 135
Source Bloomberg Ambit Capital research
Another plot that we have often used to illustrate this point on valuations is displayed in Exhibit 2 below This exhibit plots FY04 valuations as measured by PE vs ten-year relative returns over FY04-14 for the BSE200 universe of firms
The value of the R-squared makes the story self-explanatory A zero for this value indicates that the beginning-period valuations do not play any meaningful role in explaining stock returns over the next ten years
Exhibit 2 Data over FY04-14 suggests beginning period valuations do not materially influence investment returns over longer time frames
Source Ambit Capital research Note FY04-14 returns here are stock returns relative to Sensex Trailing PE has been restricted to 100
Whilst our approach of sticking to quality irrespective of valuations has worked so far (in both back-tested and live portfolio performances) there is ample literature available especially in the developed world context to suggest that value investing does deliver outperformance Thus in this note we address this disconnect between the two approaches value and quality
Rsup2 = 00025
-50
-40
-30
-20
-10
0
10
20
30
40
- 200 400 600 800 1000
FY04
-FY1
4 sh
are
pric
e C
AG
R
FY04 price to earnings
In this note we address the age-old debate on lsquovaluersquo vs lsquoqualityrsquo
Strategy
April 29 2015 Ambit Capital Pvt Ltd Page 5
lsquoValuersquo delivers over shorter time frames To test the performance of value investing in India historically we begin by defining value as stocks trading at cheap valuations (as measured by trailing PE) The market (ie BSE200 Index) is divided into five quintiles based on the trailing PE multiple and performance is measured over the subsequent year with an annual rebalance of the portfolio over the last 15 years (The portfolio rebalance is done as of the end of March every year with the prevailing share price on that day and the preceding Financial Yearrsquos earnings)
The rolling one-year returns for quintiles constructed using beginning period PE suggests that a lsquolow PErsquo strategy indeed works very well over shorter time frames Using average returns whilst the most-expensive quintile (ie Q1) has delivered CAGR returns of 10 over the last 15 years the cheapest quintile on PE (ie Q5) has managed to deliver CAGR returns of ~22 We see this as strong evidence in favour of the existence of a lsquovaluersquo premium
Exhibit 3 Rolling one-year performance of PE quintiles (with Q5 being the cheapest quintile) over the last 15 years (average basis)
Source Bloomberg Ambit Capital research Note The portfolio rebalance is done on 31st May every year Stocks with trailing PEs above 100 have been excluded from the universe Performance for the latest year has been updated till 27 April 2015
The premium continues to exist even if we use median returns instead of average returns suggesting this value premium is not the result of a few outliers On a median basis whilst the cheapest quintile has delivered CAGR returns of ~14 the most expensive quintile has delivered CAGR returns of ~6 This translates into a performance differential of ~8 for Q5 vs Q1 on a CAGR basis
Exhibit 4 Rolling one-year performance of PE quintiles over the last 15 years (median basis)
Source Bloomberg Ambit Capital research Note The portfolio rebalance is done on 31st May every year Stocks with trailing PEs above 100 have been excluded from the universe Performance for the latest year has been updated till 27 April 2015
-
400
800
1200
1600
2000
May
-00
May
-01
May
-02
May
-03
May
-04
May
-05
May
-06
May
-07
May
-08
May
-09
May
-10
May
-11
May
-12
May
-13
May
-14
Apr
-15
Q5
Q4
Q3
Q2
Q1
CAGR
22
20
17
14
10
-
200
400
600
800
1000
1200
May
-00
May
-01
May
-02
May
-03
May
-04
May
-05
May
-06
May
-07
May
-08
May
-09
May
-10
May
-11
May
-12
May
-13
May
-14
Apr
-15
Q5
Q2
Q4
Q3
Q1
CAGR
14
11
10
9
6
Rolling one-year returns for quintiles constructed using trailing PE suggests value delivers over time frames such as a year
Strategy
April 29 2015 Ambit Capital Pvt Ltd Page 6
Thus it is evident from the discussion above that over shorter time frames a lsquovalue-orientedrsquo strategy seems to have worked well historically However as can also be seen very clearly from these two exhibits performance of lsquovaluersquo has a degree of cyclicality to it In the past four years the Q5 worm seems to have stagnated even as Q1 has continued to rise This is in line with our previous work on the subject (see here) that lsquovaluersquo delivers in periods of conducive macro but does not when the macro turns challenging
The idea of the current work however is to assess the performance of lsquovaluersquo on a very long-term cross-cyclical basis In that context at least over a one-year holding horizon lsquovaluersquo has delivered in the past 15 years Whether or not does the value premium continue to exist for longer holding periods (say 3 5 and 10 years) is what we address in the next section
Strategy
April 29 2015 Ambit Capital Pvt Ltd Page 7
The lsquovaluersquo premium dissipates over longer horizons As discussed in the previous section there seems to be evidence of the existence of a significant value premium on a one-year basis In this section of the note we analyse whether or not the value premium remains over longer time frames as well
Exhibit 5 below shows the average returns for the quintiles constructed using beginning period valuations over different time horizons for the last 15 years
Exhibit 5 Performance of value over different time horizons
Quintiles based on beginning PE
Subsequent returns
1-yr 2-yr 3-yr 4-yr 5-yr 10-yr
Q1 83 105 125 132 136 133
Q2 144 145 154 167 177 171
Q3 127 136 153 152 158 133
Q4 130 123 126 136 135 114
Q5 168 163 159 150 141 94
average (Q1-Q4) 121 127 140 147 152 138 Value premium (Q5 minus average) 47 35 20 03 -10 -44
Source Bloomberg Ambit Capital research Note stock returns for a quintile at any point in time are on a median basis quintiles returns have then been averaged over time Stocks with trailing PEs above 100 have been excluded from the universe
An analysis of the returns for these quintiles over longer time frames suggests that whilst the value quintile continues to outperform as can also be seen in Exhibit 6 below the lsquovalue premiumrsquo dissipates over longer holding horizons
Exhibit 6 The lsquovalue premiumrsquo dissipates as holding horizons increase
Source Bloomberg Ambit Capital research Note stock returns for a quintile at any point in time are on a median basis quintiles returns have then been averaged over time Stocks with trailing PEs above 100 have been excluded from the universe
Thus whilst value works well over shorter time frames the link between beginning period valuations and stock returns gets weaker over long time frames and approaches zero on a ten-year basis This also explains the zero R-Squared thrown up by a regression of beginning valuations and the subsequent ten-year returns in Exhibit 2 (page 4)
One direct conclusion from this analysis is that whilst valuations play an important role (PE in this case) in driving stock returns in the near term it is the underlying trajectory of fundamentals (earnings in this case) that drives returns in the long run with valuations tending towards irrelevance We explore this point in the next section
-60
-40
-20
00
20
40
60
1-yr 2-yr 3-yr 4-yr 5-yr 10-yr
Value premium
The value premium dissipates over longer holding horizons
Strategy
April 29 2015 Ambit Capital Pvt Ltd Page 8
Decomposition of the lsquovalue premiumrsquo That returns are significantly affected by valuations in the near term but are driven by fundamental performance in the long term seems to the key learning from the findings of the previous section We will shortly demonstrate this with actual numbers at the stock level for the five PE-based quintiles but before that going through a deconstruction of returns at the index level into these two components - valuation change and earnings growth - is equally enlightening
As is evident from Exhibit 7 below on a YoY basis valuation rerating has been the single biggest driver of Sensex returns In contrast over longer time horizons Sensex returns have largely been driven by earnings compounding The 15 CAGR returns delivered by Sensex has broadly mirrored its earnings growth over the same time horizon (see Exhibit 8 below)
Exhibit 7 Whilst PE seems to be a bigger driver of Sensex returns over shorter time frameshellip
Source Ace Equity Ambit Capital research Note Both Sensex returns and change in PE have been calculated on a yearly basis starting from Decrsquo 90
Exhibit 8 hellip Sensex returns have mirrored EPS growth over long periods
Source Ace Equity Ambit Capital research Note Both Sensex and Sensex EPS have been rebased to 100 at the beginning of Janrsquo 91
Thus over the long term returns mirror earnings growth even as they are primarily driven by valuation changes in the shorter term at the index level
Coming back to stocks a decomposition of returns of the PE quintiles is shown in Exhibits 9 and 10 below Even as earnings growth stays weakest for Q5 and strongest for Q1 Q5 still manages to outperform over shorter time frames primarily owing to a valuation rerating (vs a derating for Q1) over shorter time frames
Over longer time horizons however the valuation rerating that explains the value premium becomes much smaller in magnitude in comparison to earnings growth Further earnings that become much more important over longer time horizons are significantly inferior for the value quintile vs the other quintiles (see Exhibit 9 below) As a result the premium that value enjoys on a one-year basis gradually tapers off over time
Exhibit 9 Even as earnings growth is weakest for Q5 and strongest for Q1hellip
Quintiles based on beg PE
Subsequent earnings growth
1-yr 2-yr 3-yr 4-yr 5-yr 10-yr
Q1 347 277 255 233 213 176
Q2 211 186 177 176 175 164
Q3 120 116 127 125 125 120
Q4 27 64 68 94 99 127
Q5 -15 30 56 64 69 70
average (Q1-Q4) 176 161 157 157 153 147
Q5 minus average -192 -131 -101 -93 -84 -77
Source Bloomberg Ambit Capital research
Rsup2 = 07912
(600)
(400)
(200)
-
200
400
600
800
1000
(600) (100) 400 900Sens
ex re
turn
s (
)
change in trailing PE ()
-
400
800
1200
1600
2000
2400
2800
3200
Jan-
91
Jan-
93
Jan-
95
Jan-
97
Jan-
99
Jan-
01
Jan-
03
Jan-
05
Jan-
07
Jan-
09
Jan-
11
Jan-
13
Jan-
15
SensexSensex EPS
1514
Whilst returns are primarily driven by valuation changes over shorter time frameshellip
hellipearnings become much more important over longer time horizons
Strategy
April 29 2015 Ambit Capital Pvt Ltd Page 9
Exhibit 10 hellipvaluation changes ensure better returns for Q5 over shorter time frames
Quintiles based on beg PE
Subsequent earnings multiple change
1-yr 2-yr 3-yr 4-yr 5-yr 10-yr
Q1 -184 -137 -100 -73 -45 -10
Q2 -77 -21 -15 02 13 21
Q3 10 36 39 48 46 34
Q4 166 121 121 99 89 38
Q5 239 189 161 144 136 69
average (Q1-Q4) -21 00 11 19 25 21
Q5 minus average 261 189 150 125 111 49
Source Bloomberg Ambit Capital research
Given that investing in high-quality franchises with strong longer-term outlooks has traditionally been the cornerstone of our investment philosophy it is encouraging to see that earnings growth - and not valuations - is a more important driver of investment returns over the long term
A lsquobacktestrsquo of the returns from our Coffee Can Portfolios corroborates this finding As is evident from Exhibit 11 below the ten-year returns of these portfolios have more or less converged to the earnings growth over the period with valuations (ie PE expansion) becoming almost irrelevant
Exhibit 11 CCP return decomposition shows that earnings growth is the biggest driver of portfolio returns Iteration Run-period Total returns PE expansion Earnings growth
2000 30 June 2000 ndash 30 June 2010 167 -57 237
2001 29 June 2001 ndash 30 June 2011 217 27 186
2002 28 June 2002 ndash 29 June 2012 190 07 182
2003 30 June 2003 ndash 28 June 2013 251 35 209
2004 30 June 2004 ndash 30 June 2014 316 39 266
Average 228 10 216
Source Bloomberg Ambit Capital research
However before we conclude this discussion there are two points that need to be elaborated upon
a) Are lsquovaluersquo and lsquoqualityrsquo mutually exclusive
Whilst everything boils down to earnings growth in the long term does value working over shorter time frames in turn imply that quality does not deliver over such horizons
b) Why long term
Why do we place so much emphasis on lsquolong-termrsquo investing After all as Keynes famously said ldquoin the long term we are all deadrdquo
Strategy
April 29 2015 Ambit Capital Pvt Ltd Page 10
Are value and quality mutually exclusive Given that value works well over intermediate time frames one could conclude that quality does not over such time frames More generally there is a tendency to equate value with low quality and vice versa
This view gets further enforcement from the fact that forward-looking earnings growth for Q5 stays much weaker vs Q1 suggesting that Q5 indeed comprises low-quality stocks However it is important to note that growth in accounting earnings is not in itself a conclusive evidence of quality (a company like Arshiya for example showed stellar EPS growth of ~35 over FY07-12 however Arshiya does not qualify on Ambitrsquos ldquoGood amp Cleanrdquo criteria by any stretch of the imagination)
Using RoCE as another dimension of quality we tabulate the distribution of firms with RoCEs of more than 15 across the five PE quintiles in Exhibit 12 First contrasting the performance of firms in these quintiles with RoCEs of more than 15 with that of the full quintile clearly suggests that superior RoCE leads to superior performance
More importantly the distribution of quality (defined as firms with RoCE greater than 15) across the five quintiles is more or less uniform with concentration in Q1 not being materially higher versus other quintiles
Exhibit 12 RoCE distribution in the PE quintiles
of firms
with RoCEgt15
Median returns [over May 00-May 15]
for all firms in the quintile
Median returns [May 00-May 15]
for firms with RoCEgt15
Q1 55 49 98
Q2 68 124 133
Q3 64 80 106
Q4 62 87 108
Q5 62 140 174
Source Bloomberg Ambit Capital research Note Universe is BSE200 index rebalanced annually Performance has been measured over May 00 ndash May 15
Similarly a distribution of our ten-bagger and CCP firms across the five quintiles has been displayed in Exhibit 13 below Given the stringent quality filters that we use to construct these portfolios one would expect these stocks to be trading at expensive valuations (and hence dominate Q1) especially given that quality has performed so well over the last few years
Yet what is evident from the exhibit below is that these portfolios are again uniformly spread across the first four PE quintiles (very few of these firms lie in Q5 the lowest PE quintile)
Exhibit 13 Distribution of our ten-bagger and CCP firms across the five PE quintiles
Q1 Q2 Q3 Q4 Q5 Total
Ten-baggers 23 23 37 13 3 100
Coffee-can portfolio 25 19 31 25 0 100
Source Bloomberg Ambit Capital research Note This is the distribution of our Ten-baggers 40 portfolio published on 05 January 2015 and our Coffee-can portfolio published on 17 November 2015 using trailing PE as on 23 April 2015
Similarly the distribution of our first three ten-bagger portfolios published once every year for the last three years across the five PE quintiles (basis the trailing multiples at the time of publication of the respective portfolios) is shown in Exhibit 14 below Here too the distribution is relatively uniform especially in the first four quintiles suggesting there is no undue concentration of these stocks in Q1
Distribution of high RoCE firms across the five quintiles is more or less uniform
Even our ten-bagger and CCP firms are uniformly spread across the first four PE quintiles
Strategy
April 29 2015 Ambit Capital Pvt Ltd Page 11
Exhibit 14 Distribution of our first three ten-bagger portfolios across the five PE quintiles
Q1 Q2 Q3 Q4 Q5 Total
Ten-baggers 10 25 38 25 8 4 100
Ten-baggers 20 30 30 23 10 7 100
Ten-baggers 30 33 23 30 10 3 100
Source Bloomberg Ambit Capital research Note This is the distribution of the first three iterations of our Ten-baggers portfolio published on 19 January 2012 14 January 2013 and 26 November 2013 using trailing PE as on date of publication excludes Tata Power as the company made losses on a trailing twelve month basis
In conclusion stocks may become expensive for several reasons like investors betting on a revival in the economy in general or a turnaround for a company in particular Similarly good-quality companies may go out of favour due to near-term concerns and may become cheap Therefore quality and value should not be seen as mutually exclusive groups This also helps reconcile why our ten-bagger portfolios have continued to deliver each year even as the findings of this research piece suggest that value works well over time frames such as a year Combining value and quality on the other hand wherever possible should improve returns further
In that context several quality companies that comprise our Coffee Can and ten-bagger 40 portfolios are also trading at reasonable valuations This short list of (CCP and ten-bagger) firms that fall in Q3 Q4 or Q5 on trailing PE currently is shown in Exhibit 15 below
Exhibit 15 High-quality companies from our model portfolios trading at reasonable valuations
Ticker Company name Mcap (US$ mn)
6M ADV (US$ mn)
Trailing PE
Quintile on trailing earnings
Features in which Ambit portfolio
TCS IN TCS 77309 519 245 Q3 Ten-baggers
ITC IN ITC 42801 536 286 Q3 Coffee-can Ten-baggers
HDFCB IN HDFC Bank 39831 326 24 Q3 Coffee-can
COAL IN Coal India 37210 260 174 Q4 Ten-baggers
TTMT IN Tata Motors 26418 427 103 Q5 Ten-baggers
HCLT IN HCL Tech 19357 368 172 Q4 Coffee-can Ten-baggers
AXSB IN Axis Bank 20074 510 181 Q4 Coffee-can
IDEA IN Idea Cellular 10919 166 226 Q3 Ten-baggers
TRP IN Torrent Pharma 3188 18 238 Q3 Ten-baggers
MRF IN MRF 2504 98 141 Q4 Ten-baggers
MTCL IN Mindtree 1551 44 194 Q3 Ten-baggers
IPCA IN Ipca Labs 1277 43 217 Q3 Coffee-can Ten-baggers
BIL IN Balkrishna Inds 1130 20 151 Q4 Coffee-can
CUBK IN City Union Bank 869 14 131 Q4 Coffee-can
PSYS IN Persistent Sys 894 25 191 Q3 Ten-baggers
ECLX IN eClerx Services 760 13 198 Q3 Coffee-can Ten-baggers
FNXC IN Finolex Cables 666 14 193 Q3 Ten-baggers
SF IN Sundram Fasten 595 07 272 Q3 Ten-baggers
GDPL IN Gateway Distr 622 22 222 Q3 Ten-baggers
VST IN VST Inds 408 02 173 Q4 Ten-baggers
MUNI IN Mayur Uniquoters 299 05 224 Q3 Coffee-can
Source Bloomberg Ambit Capital research Note Universe for the purpose of arriving at the quintile on trailing valuations is BSE500 index as of Octrsquo 14
Combining lsquovaluersquo with lsquoqualityrsquo should help improve returns further
Strategy
April 29 2015 Ambit Capital Pvt Ltd Page 12
Why long term Equities given the inherent volatility are usually touted as a long-term asset class This makes sense at an intuitive level - whilst the Sensex has returned over 15 CAGR returns over the last 25 years there have been intermittent periods of unusually high drawdowns For example in 2007 an investor entering the market near the market peak would have lost over 60 of value in less than twelve months of investing Thus whilst over longer time horizons the odds of profiting from equity investments are very high the same cannot be said of shorter time frames
In his book lsquoMore than you knowrsquo Michael Mauboussin illustrates this concept using simple math in the context of US equities We use that illustration and apply it in the context of Indian equities here
We note that the Sensexrsquos returns over the past 30 years have been 16 on a CAGR basis whilst the standard deviation of returns has been ~29 Now using these values of returns and standard deviation and assuming a normal distribution of returns (a simplifying assumption) the probability of generating positive returns over a one-day time horizon works out to ~512
As the time horizon increases the probability of generating positive returns goes up The probability of generating positive returns goes up to ~70 if the time horizon increases to one year the probability tends towards 100 if the time horizon is increased to 10 years (see Exhibit 16 below)
Exhibit 16 Probability of gains from equity investing in India increase disproportionately with increase in holding horizons
Source Bloomberg Ambit Capital research Note This chart has been inspired by similar work done by Michael Mauboussin in the Western context
In addition to a disproportionately higher probability of profit three other factors work in favour of longer investment horizons at the portfolio level
(a) No churn By holding a portfolio of stocks for over ten years the investor resists the temptation to buysell in the short term With no churn this approach reduces transaction costs which add to the overall portfolio performance over the long term
(b) Power of compounding Holding a stock for long periods allows the power of compounding to play out As a result winning stocks gain disproportionately and start dominating portfolio returns while losing stocks fade away to irrelevance Thus even with modest strike rates investors improve their portfolio returns by holding stocks for the long term
(c) Neutralising the negatives of ldquonoiserdquo Investing over longer time horizons is also an effective way of killing lsquonoisersquo that interferes with the investment process Consider for example how over the long term Lupinrsquos investors have had to withstand short-term disappointments to eventually compound at an impressive 33 CAGR since Janrsquo 04 (see Exhibit 17 below)
50
60
70
80
90
100
1 Hour 1 Day 1 Week 1 Month 1 Year 10 Year 100 Years
Prob
abili
ty o
f gai
ns
Years
The probability of generating positive returns increases disproportionately with increase in holding horizons
No churn power of compounding and neutralising the negatives of lsquonoisersquo are other factors that work in favour of longer investment horizons
Strategy
April 29 2015 Ambit Capital Pvt Ltd Page 13
Exhibit 17 Lupinrsquos stock price has compounded at an impressive 33 CAGR since Janrsquo 04
Source Bloomberg Ambit Capital research
The chart shown above highlights that over the past 11 years there are several extended time periods when Lupinrsquos share price has not gone anywhere ndash such as from Janrsquo 04 to Marrsquo08 and from Junrsquo10 to Janrsquo12 In spite of remaining flat over these periods Lupin has performed so well in the remaining six years that the 11-year CAGR of the share price is 33 At its simplest this is why the concept of investing for longer time horizons works ndash once you have identified a great franchise and you have the ability to hold on it for a long period time there is no point trying to be too precise about timing your entry or your exit As soon as we try to time that entryexit we run the risk of ldquonoiserdquo rather than fundamentals driving our investment decisions
-
500
1000
1500
2000
2500Ja
n-04
Jan-
05
Jan-
06
Jan-
07
Jan-
08
Jan-
09
Jan-
10
Jan-
11
Jan-
12
Jan-
13
Jan-
14
Jan-
15
Lupins share price
30042015 Land-shackled economies The paradox of soil | The Economist
httpwwweconomistcomnode21647622print 110
Land-shackled economies
The paradox of soilLand the centre of the preshyindustrial economy has returned as a constraint ongrowth
Apr 4th 2015 | From the print edition
THE history of economics has been among other
things a story of learning to care less about land
The physiocrats of 18thshycentury France saw it as
the primary guarantor of wealth Adam Smith
included it alongside labour and capital as one of
the three factors of production that combined to
generate output A little later Thomas Malthus
saw its innate scarcity as ensuring eventual
catastrophe in the face of exponential population growth
Instead of succumbing to catastrophe Western countries found ways to work around landrsquos
scarcity some of them ingeniousmdashskyscrapers artificial fertiliser railways suburbsmdashand some
nefariousmdashdispossessing the oppressed and colonised Improved transport allowed land farther
off to do the work that land close at hand had done before whether by producing crops half
way round the world or housing workers out in the suburbs High productivity allowed more
food to be grown on fewer farms
The value of land relative to GDP fell remorselessly (see chart 1) By the second half of the 20th
century land was sufficiently marginalised in richshyworld economies that it scarcely registered in
economics textbooks By the 1970s some seers noting the falling cost and increasing power of
information technology convinced themselves that the textbooks were anticipating the way of
the world land and location would soon cease to matter in real life too
Instead concern over land has come roaring back The issue is not overall scarcity but scarcity
in specific placesmdashthe cities responsible for a disproportionate amount of the worldrsquos output
The high price of land in these places is in part an unavoidable concomitant of success But it is
also the product of distortions that cost the world dear One estimate suggests that since the
1960s such distortions have reduced Americarsquos GDP by more than 13
30042015 Land-shackled economies The paradox of soil | The Economist
httpwwweconomistcomnode21647622print 210
Old
Kent
Road
to
Mayfair
Landrsquos new relevance is rooted in two main developments The first ironically enough is related
to the revolution in computers and communications that was beginning to become evident in
the 1970s In some ways this revolution has brought about the ldquodeath of distancerdquo foreseen by
Frances Cairncross (a former journalist at The Economist) Supply chains leap borders and
oceans calls to customer services can be answered a continent away But if distance has died
location has not
In the middle of the 20th century many big previously vibrant cities in the rich world were
shrinking In the 1980s in some of them that turned around Edward Glaeser of Harvard
University and Giacomo Ponzetto of CREI a research centre in Barcelona reckon that this was
because information technology made work in some knowledgeshyintensive industries far more
30042015 Land-shackled economies The paradox of soil | The Economist
httpwwweconomistcomnode21647622print 310
lucrative Financial traders could manage more money across more investors software firms
could sell their products cheaply and easily across a global market As the return to knowledgeshy
intensive activities exploded so did the economic fortunes of ideashyproducing places
There is support for this idea in research done by Thor Berger of Lund University and Carl
Benedikt Frey of the University of Oxford Before the 1980s there was no statistical link between
the skillshylevel of a cityrsquos workforce and its tendency to create new kinds of work From the 1980s
on by contrast new job categories appeared with much greater regularity in places with highly
skilled workers than in those that lacked them What is more Mr Glaeser and his colleague
Matthew Resseger find a close relationship between the population of a metropolitan area and
the productivity of workers within that area It seems that workers accumulate knowledge faster
in cities with lots of idea industries
Top cities became hotbeds of innovative activity against which other places could not easily
compete The people clustered together boosted each othersrsquo employment opportunities and
potential income From Bangalore to Austin Milan to Paris land became a scarce and precious
resource as a result the economic potential of a hectare of a rural Kentucky county is
dramatically lower than that of a hectare in Silicon Valleyrsquos Santa Clara county And there is
only so much of Santa Clara to go around
Yet more Santa Clara could be built were it not for the second and more distressing factor
behind landrsquos return the growing constraint imposed by landshyuse regulation The Santa Clara
town of Mountain View for instance is home to some of the worldrsquos leading technology firms
Yet nearly half of the cityrsquos homes are singleshyfamily buildings the population density is just over
2300 per square kilometre three times lower than in noneshytooshydensely populated San
Francisco
The spread of landshyuse regulation is not hard to understand The clustering that adds to local
economic vibrancy has costs too as the unregulated urban booms of the 19th century made
clear Crowded slums were fertile soil for crime and epidemics filthy air and water afflicted rich
and poor alike Officials began imposing new rules on those building in cities and later on
those extending them limiting heights and building designs imposing maximum densities and
minimum parking requirements setting aside ldquogreen beltsrdquo on which development was
prohibited Such regulations have steadily expanded in scope and spread to cities around the
world
As metropolitan economies recovered from their midshy20thshycentury slump populations began
growing again The numbers of people living in the central parts of London and New York have
never been higher And as demand for quality housing increased the unintended consequences
of the thicket of building regulation that had grown up in most cities became apparent
30042015 Land-shackled economies The paradox of soil | The Economist
httpwwweconomistcomnode21647622print 410
David Ricardo an eminent earlyshy19thshycentury economist who was among other things a friend
of Malthusrsquos would have recognised the issue Back when land was at the centre of the
discipline his observations led him to the idea of a rent an unearned windfall accruing to the
owner of a scarce resource
Strained food supply would raise food prices he reasoned which would encourage landowners
to bring ever more land under cultivation But higher food prices benefited all landowners A
lord sitting on highly productive agricultural land suddenly found his profits swelling not as a
result of innovation on his part but because humanity needed more of something he happened
to own This is what is happening in the worldrsquos cities today
According to data gathered by Robert Shiller of Yale University the inflationshyadjusted cost of
building new housing in America is roughly the same now as it was in the 1980s The inflationshy
adjusted cost of buying a new home by contrast has risen by 30 over the same period (during
the property bubble of the 2000s house prices climbed a great deal further before falling back)
Individual cities have experienced even larger increases From 1993 to 2013 prices in Boston and
San Francisco rose by 60 in real terms
American cities are not exceptional Economic change led to the rejuvenation of cities around
the world stress on stagnant housing stocks and soaring housing costs In many developed
economies the value of housing is an ever greater store of wealth (see chart 2)
Belleville to Rue de la Paix
Economists studying the issue generally reckon that rising housing costs are a product of the
rising cost of land David Albouy of the University of Illinois and Gabriel Ehrlich of Americarsquos
Congressional Budget Office reckon that in America land accounts for a third of total housing
costs and close to half in some metropolitan areas A high share of land in housing costs results
in the creation of large rents for landowners
If regulatory limits on building heights and density were relaxed fewer plots of land would be
needed to satisfy a given level of demand That would reduce the rents collected by landowners
since any uptick in demand could quickly be met by new development Just as soaring
agricultural productivity led to a decline in the relative economic power of rural landowners in
the 19th and 20th centuries the relaxation of strict limits on development would lead to a
decline in property wealth relative to the economy as a whole More of the gains of economic
activity would flow to workers and investors
Instead building regulations keep urbanshyland productivity low and the costs are staggering A
2005 study by Mr Glaeser and Raven Saks of Americarsquos Federal Reserve and Joseph Gyourko
30042015 Land-shackled economies The paradox of soil | The Economist
httpwwweconomistcomnode21647622print 510
of the
University of Pennsylvania attempted to derive the share of property costs attributable to
regulatory limits on supply In 1998 this ldquoshadow taxrdquo as they call it was about 20 in
Washington DC and Boston and about 50 in San Francisco and Manhattan Matters have
almost certainly got worse since then
Similar work by Paul Cheshire and Christian Hilber of the London School of Economics
estimated that in the early 2000s this regulatory shadow tax was roughly 300 in Milan and
Paris 450 in the City of London and 800 in its West End The lionrsquos share of the value of
commercial real estate in Europersquos most economically important cities is thus attributable to
rules that make building difficult
One may find it hard to sympathise with Mayfair hedge funds facing high rents But the net
effect of these costs is felt more by the poor than by the rich Take American homeowners The
30042015 Land-shackled economies The paradox of soil | The Economist
httpwwweconomistcomnode21647622print 610
fact that 60 of households own property might seem to suggest that rising house prices and
inflated land values were good for a large swathe of the middle class Yet Edward Wolff of New
York University notes that the middle class enjoyed much less of a boost to wealth because of an
accompanying rise in mortgage debt (see chart 3) Meanwhile poorer Americans who rent their
homes experienced soaring housing prices as a large and sustained increase in their cost of
living
Housing wealth has played a critical role in rising inequality to which Thomas Piketty an
economist at the Paris School of Economics drew attention in his bestselling book ldquoCapital in
the TwentyshyFirst Centuryrdquo In a recent paper Matthew Rognlie a doctoral student at MIT
noted that the rising share of national income flowing to owners of capital rather than workers
30042015 Land-shackled economies The paradox of soil | The Economist
httpwwweconomistcomnode21647622print 710
is largely attributable to increased payments to owners of housing Capital income from housing
accounted for just 3 of the total in 1950 but is responsible for about 10 today
Land rents are also captured by landowners in many emerging markets According to CBRE a
property company Beijing and New Delhi are among the worldrsquos ten most expensive office
markets while Kuala Lumpur and Jakarta are among those with the fastest price increases
Extremely fast growing areas are often crucial to developing economies which means poorly
regulated property markets can do a lot of harm In Indiarsquos big cities onerous permitting
procedures tight rent control and strict limits on how land may be used have heavily distorted
patterns of growth and the allocation of its benefits
Growth in the rents available to property owners fuels corruption and wastes resources
Landowners work to strengthen development restrictions while politicians cash in on their
ability through selective development approval to grant fortunate supplicants a windfall In
economies where political corruption is already a problem the renaissance of land may be
especially corrosive In October 2014 the Times of India reported that the bribes required to
clear the various stages of the planningshypermission process in central Mumbai could add up to
as much as half of basic building costs
30042015 Land-shackled economies The paradox of soil | The Economist
httpwwweconomistcomnode21647622print 810
Residential property value per square mile$m 2009-13
Price persquare mile
Totalvalue
Average price Value perperson
Owneroccupancy
Housingdensity
Populationdensity
Source Census Bureau The Economist Double-clicktap any county to zoom
National State County072 New York (7) 46 New York (1) 16548
0 to 039 04 to099
1 to 199 2 to 399 4 to 1499 15 to2499
Over 250
The ugliest effect of the return of land though may be the brake it applies to the economy as a
whole One of the main ways economies increase worker productivity and thus grow richer is
through the reallocation of people and resources away from lowshyproductivity segments to more
efficient ones In business this means that bad firms go bust and good ones grow to great size
Something similar should hold for cities Where workers can be put to use at high levels of
productivity labour scarcity will lead to fast growing pay packets Those pay packets will attract
workers from other cities When they migrate and find new highshypaying work the whole
economy benefits
Mediterranean Avenue to Boardwalk
But that process is now breaking down in many economies For workers to move to the high
30042015 Land-shackled economies The paradox of soil | The Economist
httpwwweconomistcomnode21647622print 910
wages on offer in San Francisco they must win an auction for a home that provides access to
the local labour market The bidding in that auction pushes up housing costs until there are just
enough workers interested in moving in to fill the available housing space Salaries that should
be sending comeshyhither signals are ending up with rentiers instead and the unfairness can
trigger protest as it has in San Francisco Many workers will take lowershypaying jobs elsewhere
because the income left over after paying for cheaper housing is more attractive Labour ends
up allocating itself toward lowshyproductivity markets and the whole economy suffers
ChangshyTai Hsieh of the University of Chicago Booth School of Business and Enrico Moretti of
the University of California Berkeley have made a tentative stab at calculating the size of such
effects But for the tight limits on construction in Californiarsquos Bay Area they reckon
employment there would be about five times larger than it is In work that has yet to be
published they tot up similar distortions across the whole economy from 1964 on and find that
American GDP in 2009 was as much as 135 lower than it otherwise could have been At
current levels of output that is a cost of more than $2 trillion a year or nearly $10000 per
person
The good news is that the worldrsquos urbanshyland scarcity is largely an artificial problem The bad
news is that that does not make it a soluble one Redressing strict land regulation is among the
most politically fraught of policy issues It is in many ways like other toxic issues such as trade
or immigration The society on the receiving end of new imports or population inflows benefits
as a whole but those put out of business by competition or dismayed by cultural change feel a
disproportionate level of damage and organise in opposition And in the case of land values this
opposition will be rich
There are ways to address this with policy Governments could aim specific assistance at those
harmed by dense development as they have to those affected by liberalised trade Disbursing
some of the tax revenue earned as a result of new development to landowners within a small
area around that development to compensate for shortshyterm hardship would reduce opposition
to new building
Or they could heed the advice of Henry George an American follower of Ricardo who in the
1880s made the case for a landshyvalue tax It has many theoretical virtues Most taxes dampen
distort or displace economic activity by changing incentives on the margins But a land tax
cannot reduce the supply of land and it would stimulate economic activity by penalising those
whose land is unproductive And your tax base is always right theremdasha city lot cannot be
whisked off to Luxembourg
The mayor of New York City Bill de Blasio hopes that taxing vacant lots by value will help deal
with urban blight in the Bronx and elsewhere But there are practical problems with a land tax
30042015 Land-shackled economies The paradox of soil | The Economist
httpwwweconomistcomnode21647622print 1010
mdashperhaps the largest of which is that by its very
nature it hits the wellshyconnected rich hardest
Even fiscally purist Estonia which adopted a land
tax in 1993 has complicated it with multiple
bands including an exemption for homeowners
Those already blessed with property may also
object to the other obvious approach to the
problem faster and highershycapacity transport
links allowing the benefits to be spread farther
afield Some ways of improving transportmdashsuch
as congestion charges on trafficmdashmay be cheap
but especially in big cities new infrastructure is a
slow and costly undertaking as veterans of
Bostonrsquos tunnelshyenhancing ldquobig digrdquo can attest A
new underground railway line in London
Crossrail is currently Europersquos most expensive
infrastructure project
In the absence of jet packs all round what else
might technology offer In time perhaps it could
do to location what it did to brute distance
abolishing the problem Virtual reality and social
networking might combine to provide the benefits
of dense populations without the propinquity Unlikely yesmdashbut perhaps no more so than a
skyscraper or a subway train to David Ricardo
From the print edition Briefing
23042015 Indiarsquos Central Bank Chief Looks for More Accommodation shy Real Time Economics shy WSJ
httpblogswsjcomeconomics20150420indiasshycentralshybankshychiefshylooksshyforshymoreshyaccommodationtabprintmg=blogsshywsjampurl=http253A252F252Fblhellip 14
April 20 2015 411 PM ET
ByJon Hilsenrath
Raghuram Rajan governor of the Reserve Bank of IndiaKuni TakahashiBloomberg News
Reserve Bank of India Governor Raghuram Rajan is keeping his options open for additional reductionsin benchmark interest rates
The central bank has cut rates twice this year and could cut rates further if it sees more signs that inflationis easing Mr Rajan said in an interview with The Wall Street Journal on the sidelines of the InternationalMonetary Fundrsquos spring meetings
ldquoWersquore going to look for itrdquo Mr Rajan said ldquoWersquore going to look to see the course of disinflation continuerdquo
The interview touched on a range of issuesndashincluding puzzles about slow global economic growth and theprospects for interestshyrate increases by the US Federal ReserveA lightly edited transcript of key excerpts follow
WSJ What is your read on how the global economy is performing right now
Indiarsquos Central Bank Chief Looks for MoreAccommodation
23042015 Indiarsquos Central Bank Chief Looks for More Accommodation - Real Time Economics - WSJ
httpblogswsjcomeconomics20150420indias-central-bank-chief-looks-for-more-accommodationtabprintmg=blogs-wsjampurl=http253A252F252Fblhellip 24
RAJAN It is weaker than anybody thought would be the case seven years after the crisis I am in thecamp that says this reflects weakness that was there before the crisis and was masked by a fair amountof borrowing That borrowing may have weakened us even more but there is some fundamentalweakness Whether it is low productivity or aging I will leave to other people to sort out
We donrsquot fully understand the ramifications of aging as yet We are still debating whether Japan post-1992did fine given its aging population and shrinking labor force or whether it was really very weak growthSome people say it was fine Per capita growth or growth per person employed comes out looking prettygood compared to other industrial economies But when you look at overall growth it looks pathetic Whatexactly was going on
Similarly we donrsquot understand the true cost of minor deflation Was that cause or effect We are veryworried about deflation We made it a real bogeyman In the Japanese situation yes it was a long period ofsustained minor deflation but it never got to be accelerating deflation It isnrsquot clear to me that we got into asituation where people postponed purchases because they thought they would be cheaper next year Sowhat are the true costs from deflation and are they so high that we have to pull out all of the stops to avoidit at any cost
WSJ One of the arguments is that it raises real interest rates
RAJAN It does but we have also found that we can have negative interest rates Also look at investmentIs it high real interest rates that are keeping people from investing or is it something else You couldpostulate some real interest rate at which people would invest If that real interest rate is negative threepercent or negative four percentndashif people need to be paid money to investndashisnrsquot that telling you somethingelse is wrong in the economy People want to just dump assets into the ground because something else isoff I donrsquot know if the real problem keeping investment low is excessively high real interest rates I donrsquotthink we fully understand why investment is so weakTwo factors make growth an imperative for industrial countries today One is that entitlements are loomingThey are coming much closer as populations age That is augmented by the debt that has been taken onThese two have to be paid down which means you need growth to pay them down The other is thegrowing effects of inequality You have to worry about the degradation of the middle-class job as well asthe fact that many people are moving down to the lower middle class That also puts pressure on policymakers to do something Both of these are coming together at the same time wersquore trying to pull out all ofthe stops to get growth going It just doesnrsquot seem to be coming in a sustainable way so we get more andmore adventurous
WSJ How would you explain the slowdown wersquove seen so far this year
RAJAN We just donrsquot seem to be getting escape velocity This virtuous cyclendashwhere everybody believesthat everything is going to be all right so they start investing then investment creates jobs jobs createdemand and demand creates investmentndash that virtuous cycle is just not happening Every time it seemslike it is happening you have one more quarter of terrible growth
WSJ Are you talking globally or about the US
RAJAN Irsquom talking about the US because it is now the engine to some extent of industrial-countrygrowth I donrsquot know why we are not getting that self-sustaining ramp up
23042015 Indiarsquos Central Bank Chief Looks for More Accommodation - Real Time Economics - WSJ
httpblogswsjcomeconomics20150420indias-central-bank-chief-looks-for-more-accommodationtabprintmg=blogs-wsjampurl=http253A252F252Fblhellip 34
WSJ This International Monetary Fundrsquos World Economic Outlook points to the slowdown in emerging-market potential growth It actually sees a bigger slowdown in emerging markets than the developed worldHow do these stagnation stories affect you running an emerging-market central bank
RAJAN Emerging markets have become dependent on industrial-country demand Strong growth inindustrial country demand pulled demand up for emerging-market economies We didnrsquot have to createdemand ourselves Creating demand is a very fraught process It is very easy to lapse from modestdemand creation to credit booms to runaway capital spending You need good macro institutions to do thatcarefully Emerging markets got into trouble in the 1990s because they didnrsquot do that well So weoutsourced demand creation to the industrial countries Unfortunately the demand creation there wasunsustainable Now it got pushed back to the emerging markets And again we had the unsustainabledemand creation that happened in emerging markets whether it is the enormous debt-fueled investmentthat took place in some countries like China or the consumption booms that took place in some otheremerging markets We had corporate borrowing in places like India Now a number of emerging marketshave to slow down because they got too much
WSJ When we sat down here a year or so ago the problem you were trying to solve was too muchinflation now you are running below target
RAJAN It is a corollary of very weak demand There is also a greater globalization of labor markets Youcanrsquot on your own start demanding high wages because there is competition elsewhere and that tends toput a lid on wage increases It makes it easier to control inflation when wage growth doesnrsquot get out ofcontrol very easily The global labor market the low capacity utilization around the world is essentiallykeeping a lid on inflation When you couple that with the commodity-price declines especially oil wherethere are some supply-side effects also we are in a very very benign inflationary environment Some of itwould classify as bad deflation in the old sense excessively weak demand Some of it would classify asgood deflation new sources of supply and more-efficient sources of supply which bring prices downAs far as India goes yes our problem was very high inflation some of it driven by domestic factors suchas an escalating price of food feeding from food into second round effects in services It wasnrsquot just foodEducation costs construction costs were all going up Now I think that has slowed down considerablyOur wholesale price inflation index is negative 2 That essentially reflects global inflation Our domesticprice inflation consumer price inflation is 52 Wersquore doing reasonably well on the domestic inflation fronthelped by global disinflationary pressures Also we have managed to get more control of domestic pricesI am hopeful that there is a steady process of further disinflation Our intent is over the next two and a halfyears to reach the midpoint of our target which is 4 We want to get under 6 by January 2016 and thenwersquoll go toward 4 by January 2018
WSJ The Greenspan era was marked by the idea of opportunistic disinflation Is this an opportunity foryou to get to 4 sooner than planned
RAJAN We set a two-year time frame because we believed that gave us enough time to get there withouttoo much of a growth sacrifice balancing growth and disinflation If there was some global event thathelped me reach that faster would I say lsquoNo no I donrsquot want it Take it backrsquo Two years is about the timethat we can do it reasonably If opportunity strikes would I refuse it No
WSJ Is the period we are in right now an opportunity or a threat to the tradeoff
RAJAN I see the combination of circumstances including the actions the government has taken to
23042015 Indiarsquos Central Bank Chief Looks for More Accommodation - Real Time Economics - WSJ
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Copyright 2015 Dow Jones amp Company Inc All Rights ReservedThis copy is for your personal non-commercial use only Distribution and use of this material are governed by our Subscriber Agreement and by
copyright law For non-personal use or to order multiple copies please contact Dow Jones Reprints at 1-800-843-0008 or visitwwwdjreprintscom
moderate food prices the sharp reduction in oil prices around the world as beneficial and supportingfactors that make it easier for us to obtain our inflation objectives Did I know that all of this will be therewhen we embarked on this No Therefore it has made it easier for us to be accommodative today
WSJ You cut rates twice this year Is there room for more accommodation
RAJAN Wersquove said wersquore going to look for it Wersquove said wersquore going to look to see the course ofdisinflation continue We also wanted the banks to start transmitting some of the rate cuts that wersquove doneWe continue examining the process of fiscal consolidation And finally international developments Wersquorewatching the data like everybody else We have said we have moved toward accommodation but we needto be convinced that a number of factors are coming together to know there is room for moreaccommodation
WSJ Does this latest print on inflation move you in that direction
RAJAN I have resisted commenting on every print that comes in Clearly it has surprised the marketpositively
WSJ Wersquore talking about slow growth Wersquore talking about global disinflation Wersquore talking about how hardit is to reach escape velocity Can the rest of the world afford for the Fed to raise rates in this environment
RAJAN Can we afford for the Fed not to The worry is that the longer we stay in this environment thedeeper are the distortions that wersquoll have to undo eventually At some point yoursquove got to say lsquoOK enoughWersquove got to get outrsquo The longer we stay here the more the distortions pick up There will be no perfecttime
0
20
40
60
80
0
20
40
60
80
Voice andAccountability
Politicalstability
Governmenteffectiveness
Regulatoryquality
Rule of law Control ofcorruption
Percentile
World governance indicatorIndia
Asia ex Japan
Percentile
-10 -5 0 5 10
IndiaThailand
ChinaMalaysia
TaiwanAsia average
IndonesiaKorea
Hong KongSingapore
Philippines
Change in ranking (2004-13)
Government effectiveness
0 5 10 15
Poor public healthInsufficient capacity to innovate
Tax regulationsInflation
Crime and theftPoor work ethic in national labor force
Policy instabilityInadequately educated workforce
Government instabilitycoupsRestrictive labor regulations
Inefficient government bureaucracyCorruption
Inadequate supply of infrastructureForeign currency regulations
Tax ratesAccess to financing
The most problematic factors for doing business in India
Percent of responses
22
23
24
25
26
27
22
23
24
25
26
27
1960 1970 1980 1990 2000
YearsYears
Average age at entry for IAS
Indian Administrative Service years denote starting of respective decades
50
52
54
56
58
60
62
64
50
52
54
56
58
60
62
64
India Malaysia HK US China UK Singapore
YearsYears
Age of the head of civil service
For US and China avg age of senior bureaucrats are shown
0
1000
2000
3000
4000
5000
6000
0
1000
2000
3000
4000
5000
6000
04 05 06 07 08 09 10 11 12 13 14
INR billionINR billion
Stalled Projects
Infrastructure
Industrial
Governance Indicator Components Source
Government Effectiveness Quality of bureaucracy institutional effectiveness EIU IPD WCY WMO GWPExcessive bureaucracy red tape
Public school basic health services drinking water and sanitation electricity grid transport infrastructure maintenance and waste disposalGovernment economic policies do not adapt quickly to changes in the economyIndependence of public service from political interferenceGovernment decisions are not effectively implementedBureaucracy hinders business activityPolicy direction is not consistentBureaucracy quick decision makingclear policy for foreign investors
EIU Economist Intelligence Unit WCY Institute for management amp development World Competitiveness Yearbook IPD Institutional Profiles Database WMO Global Insight Business Conditions and Risk Indicators GWP Gallup World Poll
Dependent variable
Model Baseline With low income countries
Government effectiveness scores 028 (878)
040(520)
Estimation method Country Fixed Effects Country Fixed EffectsSample Period 1998-13 1998-13Observations 140 112R-squared 098 094t-statistics in parenthesis significant at 1 level
Real GDP per capita annual growth
Note CVC Central Vigilance Commission IO Inquiry Officer AGS Accused Government Servant PO Presenting Officer DOPT Department of Personnel amp Training DA Administrative department UPSC Union Public Service Commission
Complaint PreliminaryInvestigation
Whether minormajor
penaltyProceedings
Consultation with CVC
Whether minormajor
penaltyProceedings
Vigilance officer to draw up charges
Delivery of articles of charges statement of imputation list of
document amp witnesses
AGS to submit statement of
defence
Acceptance or rejection of
charges by AGSConsultation with
CVC
Consultation with DOPT DA may review or
modify chargesAppointment of
inquiring authorityAppointment of
presenting officerForwarding
documents to inquiry officer
Inquiry of officer fixes day for preliminary
hearing
Accused govt servant informs
about the assisting govt servant
Acceptance or rejection of
charges by AGS
On first hearing the IO to ask PO to
produce evidence and adjourn the case
PO to allow inspection of
documents by
Issue of notices to witnesses
PO to lead evidence Examination of
witnesses on behalf of DA Cross examine by AGS Re-examine by PO Examine by IO
Additionalevidence on behalf of DA
Statement of defence by AGS
evidence on behalf by AGS
Examination of AGS
Final hearing or written briefs
Submission of report of IO
DA to deliver copy of report to AGS and seek
comments
Consultationwith UPSC
Consultationwith CVC
Final Order
Real GDP Growth (year-over-year)
GS Consensus GS ConsensusAsia ex-Japan 62 61 61 63 63
China 77 74 73 72 71India 47 56 54 65 62South Korea 30 35 35 38 37Hong Kong 29 21 23 29 30Taiwan 21 37 36 39 36ASEAN 50 45 44 52 52
Singapore 38 35 32 42 38Malaysia 47 61 57 52 52Thailand 29 13 13 45 43Indonesia 58 51 52 52 56Philippines 72 61 63 65 63
USA 22 22 22 30 31Euro area -04 07 08 10 12Japan 15 09 11 11 13GS estimates for annualized growth rate of potential output from 2013-16
Fiscal year basis 2013 is India FY14 (Q2 2013-Q1 2014)Source Consensus Economics Goldman Sachs Global Investment Research
2013 2014 2015 Potential Growth
77603840
08
37
45
4050
60602311
Consumer Prices (year-over-year)
GS Consensus GS ConsensusAsia ex-Japan 33 32 36 35 37
China 26 22 23 25 27India 95 77 80 70 69South Korea 13 15 15 26 22Hong Kong 43 43 39 32 35Taiwan 08 15 14 18 18ASEAN 40 41 41 44 43
Singapore 24 15 15 22 21Malaysia 21 30 32 26 39Thailand 22 22 22 27 25Indonesia 64 61 61 67 60Philippines 29 43 43 35 39
USA 15 17 18 14 18Euro area 13 05 05 08 10Japan 04 28 28 17 18Fiscal year basis 2013 is India FY14 (Q2 2013-Q1 2014) 80 as the inflation target in January 2015Core inflation target
ECB aims to maintain inflation rates below but close to 2 over the medium term
Source Consensus Economics Goldman Sachs Global Investment Research
2013 2014
20
25-35-
30-502020
2015 Inflation TargetRange
3580
-
-
-05-30
35-55
Policy Interest Rates (percent)CurrentNov 6 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q
Asia ex-JapanChina 306 320 330 343 310 320 330 350 350India 800 800 800 800 800 800 800 800 800South Korea 200 250 250 225 200 200 200 225 250Hong Kong - - - - - - - - -Taiwan 19 19 19 19 19 19 20 21 21ASEAN
Singapore - - - - - - - - -Malaysia 325 300 300 325 325 350 350 350 350Thailand 200 200 200 200 200 200 200 225 275Indonesia 750 750 750 750 775 800 800 800 800Philippines 400 350 350 400 400 400 400 400 400
USA 007 008 010 009 013 013 013 038 063Euro area 005 025 015 005 005 005 005 005 005Japan 006 010 010 010 010 010 010 010 010Policy interest rates China 7-day repo India repo rate Korea 7-day repo Malays ia overnight policy rate
Thailand 1-day repo Philippines repo rate Indonesia 1-m onth SBI rate Taiwan redis count rate USA Fed funds effective rate
Euro Area Main refinancing operations fixed rate Japan Overnight call rate
Source Goldman Sachs Global Inves tment Research
2014F 2015F
Exchange Rates (local currency units per USD)
Current 3-Month Horizon 6-Month Horizon 12-Month Horizon
Nov 6 Forward Forecast Forward Forecast Forward ForecastAsia ex-JapanChina 615 616 616 619 615 624 615India 6133 6219 6100 6310 6200 6498 6300South Korea 1078 1082 1100 1085 1130 1088 1140Hong Kong 78 78 78 78 78 78 78Taiwan 305 305 305 304 305 303 310ASEAN
Singapore 129 129 126 129 127 129 127Malaysia 334 336 327 338 330 342 335Thailand 327 328 325 330 330 333 340Indonesia 12083 12290 12400 12515 12700 12925 13000Philippines 450 451 455 452 460 454 465
Euro area 126 126 123 126 120 126 115Japan 1136 1135 1160 1133 1180 1130 1200 USD per EuroSource Goldman Sachs Global Investment Research
India Economic Watch
When Im 6353 Will RBI stillhold me
GEM Economics | Asia | India26 April 2015
+91 22 6632 8653India EconomistDSP Merrill Lynch (India)indranilsenguptabamlcom +91 22 6632 8682India EconomistDSP Merrill Lynch (India)aguptabamlcomMerrill Lynch (Singapore)
Bottom line Token resistance now US$15bn defense atRs65USDHow will the RBI react clients ask after the INR crossed Rs63USD levels We continue to expect it to offer token resistance now given USD strength and sell US$15bn to defend Rs65USD The RBI should continue to buy at Rs60-62USD After all the INR always seasonally weakens in April-September our Asia FX strategist Adarsh Sinha sees Rs64USD by September Second Governor Rajan will understandably want to hoard precious FX reserves to fight any contagion during our expected September Fed hike Finally the INR remains 13 over valued on 36-country REER terms Looking ahead we see 3 swing factors First next weeks FOMC meeting will naturally shape the RBI immediate FX policy Second quarterly earnings will drive FII equity flows Finally a lull in FX repayments till September should support INR
RBI to hold Rs60-65USD How will the RBI react clients ask after the INR crossed Rs63USD levels We continue to expect it to offer token resistance now given USD strength The RBI should continue to pursue a 3-step FX policy
Rs60-62USD RBI will continue to buy FX
Rs63-64USD It will offer token defense selling say US$500mn-US$1bn as it did in December-January and now
Rs65USD We see full-scale FX intervention of say US$15bn
1 INR weakens seasonally in April-September We continue to highlight that INR always weakens seasonally in April-September (Chart 1) Trade seasonality turns in favor of imports and against exports as the summer and the monsoon slackens industrial production In fact our Asia FX strategist Adarsh Sinha sees Rs64USD by September Do read our last FX report here
2 RBI to recoup FX to fight competitive monetary easingWe expect Governor Rajan to hoard precious FX reserves to fight any contagion during our expected September Fed hike Needless to say we fully share his concerns about excessive global liquidity from competitive monetary easing Our BoP estimates show that the RBI will be able to buy US625bn in FY16 to take the import cover to over 10-months (Table 1 and Chart 2)
3 INR 13 over valued outperformed peersWe continue to highlight that the INR remains 132 over valued in 36-country REER terms (Chart 3) It has also outperformed EM peers since December 2013 despite having depreciated around 2 over the last week (Chart 4) There is as such no great imperative for very forceful RBI action when Delhi is worried about a strong INR
I nd i a Econo mic Wa tch
26 A pr i l 2 015
2
We continue to advise investors to see the 36-country REER as a measure of competitiveness rather than the 6-country REER that over-values INRrsquos strength far more at 252 in REER terms The 6-country REER really measures cross-currency pressures as it has been created out of hard currencies rather than out of currencies of Indias trading partners For details see our report here
1 Fed Dovish but no clear guidance The April FOMC statement will naturally shape the immediate RBIs FX policy Our US economists however do not expect any clear guidance against a June rate hike or in favor of their September rate hike call The April FOMC statement should note the disappointing recent data which should sharply reduce the odds of June liftoff However we do not expect the statement to explicitly rule out a June hike as the FOMC wants to retain policy flexibility If market participants are looking for a clear sign that the Fed will not hike in June they are likely to be disappointed Do read our US economists here
2 Weak earnings FII G-sec limit hike swing factor Weak quarterly earnings will likely impact FII equity flows especially with the rebound in Chinese equities Our equity strategists expect BSE Sensex March quarter earnings at a mere 1 While the profits recession is global the BSE Sensex is no longer cheap A saving grace is that we continue to expect a hike of US$5bn in the FII G-sec limit soon Do read our equity strategists here
3 Lull in FX repayments till September A lull in FX repayments till September should support INR (Chart 5) In any case we continue to expect Indian banks and corporates to roll over their FX liabilities
I nd i a Econo mic Wa tch
26 Ap r i l 201 5
3
Source BofAML Global Research Estimates Bloomberg
Current Account -324 -786 -1008 -839 -265 -155 of GDP -17 -17 -21 -18 -13 -07Trade balance -1476 -346 -386 -392 -1395 -1355- Exports 3186 817 853 790 3291 3546- Imports 4662 1164 1238 1182 4686 4901ow Oil imports 1668 408 419 342 1363 1015ow Gold imports 287 70 76 111 325 432
Invisibles 1152 268 285 309 113 120ow private transfers 655 164 163 164 674 708ow income from reserve assets 35 07 10 13 50 50
Capital Account 488 199 187 234 925 880Foreign investment 264 206 180 136 650 550- FDI 216 82 82 74 30 30- FII+ 48 124 98 63 35 25
Banking capital (ex RBI fwds FY15-16) 254 -01 -04 105 15 10- NRI deposits 389 24 41 36 14 10
External assistance 10 00 07 03 25 5ECBs 118 17 17 18 8 12Short term credit -50 02 -16 -14 2 6Other Capital -108 -25 03 -14 00 00Errors and Omissions -09 -08 -17 -18 00 00Overall balance 155 112 69 132 660 725MemoRBIs forex intervention (incl RBI fwds FY15-16) 110 106 52 116 585 625Import Cover (in months) 78 93 104Source RBI BofA Merrill Lynch Global Research estimates
97
98
99
100
101
102
INRUSD avg seasonal factors (FY10-FY15)
I nd i a Econo mic Wa tch
26 A pr i l 2 015
4
Source BofAML Global Research Estimates RBI
Source RBI BofA Merrill Lynch Global Research estimates
Note As on 25 April 2015 Source BofA-ML Global Research Estimates Bloomberg
35
40
45
50
55
60
65
-2
3
8
13
18
Import cover (months) INRUSD (RHS)
90
95
100
105
110
115
120
125
36 country REER (Trade Wt) 6 country REER (Trade wt)
-65
-55
-45
-35
-25
-15
-5
Brazil Russia India China Turkey Indonesia Mexico
since 22 May13 since 18 Dec13 since 1 Aug14
I nd i a Econo mic Wa tch
26 Ap r i l 201 5
5
Source BofA-ML Global Research Estimates Bloomberg
Special DisclosuresIn accordance with the SEBI (Foreign Portfolio Investors) Regulations 2014 andwith guidelines issued by the Securities and Exchange Board of India (SEBI) foreign investors (individuals as well as institutional) that wish to transact the common stock of Indian companies must have applied to and have been approved as per SEBI (Foreign Portfolio Investors) Regulations 2014 Each investor who proposes to transacts common stock of Indian companies will be required to obtain Foreign Portfolio Investor (FPI) registration as per SEBI (Foreign Portfolio Investors) Regulations 2014 Certain other entities are also entitled to transact common stock of Indian companies under the Indian laws relating to investment by foreigners BofA Merrill Lynch reserves the right to refuse to provide a copy of research on common stock of Indian companies to a person not resident in India American Depositary Receipts (ADR) representing such common stock are not subject to these Indian law restrictions and may be transacted by investors in accordance with the applicable laws of the relevant jurisdiction Global Depository Receipts (GDR) and the Global Depository Shares (GDS) of Indian companies Indian limited liability corporations have not been registered under the US Securities Act of 1933 as amended and may only be transacted by persons in the United States who are Qualified Institutional Buyers (QIBs) within the meaning of Rule 144A under the Securities Act Accordingly no copy of any research report on Indian companies GDRs or GDSs will be made available to persons who are not QIBs
DSP Merrill Lynch Limited (DSP Merrill Lynch)DSP Merrill Lynch provides the following services in India Equity Sales amp Trading Futures amp Options Electronic Trading Equity Capital Markets Debt Capital Markets MampA and Global Wealth Management SEBI Regn Nos StockBroking INBINF 011348134 INBINF 231348138 Merchant Banker
- 05 10
15 20 25 30 35 40
45
Bond repayment Loan Repayment Total FX repayments
US$bn
The Economist
After Nepalrsquos earthquakeAll latest updates
To the rescueA 78-magnitude earthquake brings tragedy and reveals political shortcomings
Apr 29th 2015 | DELHI AND KATHMANDU | Asia
A CLOUD of brown dust filled with rock doves
rose over Kathmandu the Nepali capital when
the earthquake struck on April 25th The
ground shook so violently as the Indian
tectonic plate lurched three metres (10 feet)
northward that people struggled to stand The
earthquake rattled windows in Delhi the
Indian capital 1000 kilometres (625
miles) away
Older parts of Kathmandu are now rubble A 62-metre tower put up in the 19th century
Dharahara collapsed More buildings fell in Durbar square a UNESCO world-heritage site
that is home to temples that are hundreds of years old Both sites had been thick with locals
as well as foreign visitors Many were trapped and died At least one newish hotel also folded
killing dozens But for the most part the cityrsquos concrete-and-glass structures stayed up
despite notoriously poor enforcement of building codes Some credit is due to public
campaigns by non-governmental groups and the UN They have trained builders to
strengthen the joints of concrete beams Hundreds of schools in Kathmandu have been
retrofitted in recent years Thanks to that expertsrsquo worst fears of a big earthquake
flattening three-fifths of the capital and killing 100000 were not fulfilled
Thanks too to luck the main earthquake (there were aftershocks) came at noon on a
Saturday when schools and offices were closed and many people were up and about
outside Even so the suffering is horrendous By mid-week over 5000 were confirmed dead
The prime minister Sushil Koirala predicts that the toll could reach 10000 Most victims
are in the Kathmandu valley which has seen rapid and haphazard urban growth over the
past couple of decades partly because a civil war that ended in 2006 pushed villagers
towards the capital The valleyrsquos buildings are especially vulnerable since they rest on
sediment layers that are prone to liquefaction Rebuilding the stricken areas could cost
$10 billionmdasha huge bill for one of Asiarsquos poorest countries
Three days after the quake the roads from Kathmandu were thronged with people taking
food and tents to nearby villages In Kavrepalanchok district an hourrsquos drive from the
capital villagers camped in fields under plastic sheets They complained of the stench from
human corpses and dead livestock They badly needed water food and medicine
Two parents digging in the rubble for the body of their 16-month-old daughter said
local police would not help
Next door in Sindhupalchok district every
mud-and-stone house was cracked and many
had collapsed outright The government
guesses that 530000 houses are damaged in
all and over 70000 destroyed Almost no one
has insurance The UN says 8m people in a
population of nearly 30m are affected in some
way The epicentre was 80km north-west
of the capital in a steep and mountainous area Landslides reportedly swept entire villages
off hillside Aerial footage shows houses that have collapsed into circles of dust Unseasonal
rain and cold and continuing aftershocks including one with a magnitude of 69 have left
survivors exposed
On Mount Everest east of Kathmandu tremors set off an avalanche that crushed at least 18
climbers and Sherpas It has been a bad time for Nepali tourism In October freak
snowstorms killed 43 on a lower-altitude trail And a year ago an avalanche on Everest killed
16 Nothing puts off the most determined climbers but a tourism industry that is central to
the livelihoods of many looks troubled
irected largely at the neighbour In a radio address heard in both countries Indiarsquos prime
minister Narendra Modi vowed to ldquowipe the tears of every Nepalirdquo adding that Nepalrsquos pain
was also Indiarsquos Millions of Nepali migrants live and work in India sending remittances
home These will now be badly needed
Mr Modi wants to be seen leading and appears to be guiding the relief effort better than
Nepalrsquos own leaders Within hours of the first jolts the Indian army began delivering aid
There is a geopolitical dimension to the help A Modi adviser talks of an Indian strategy of
becoming ldquomore confident abroadrdquo That starts with winning influence in the region Mr
Modi has twice visited Nepal since he came to office a year ago after a gap of 17 years during
which no Indian prime minister deigned to go He promotes Indian investment in Nepali
hydropower And Nepal is a main beneficiary of Indiarsquos trebling of aid over the past
three years to 94 billion rupees ($15 billion) China presumably features in Mr Modirsquos
calculations It influence has often appeared to be in the ascendant in Nepal which India
traditionally considers to be its own back yard
Several countries and UN agencies quickly promised financial and other help So many
donors rushed search-and-rescue teams field hospitals blankets tents and medical
equipment that the main airport in Kathmandu grew overwhelmed Within a day of the
earthquake China delivered a military rescue team 13 tonnes of aid and promised over $3m
in immediate help It also played down talk of rivalry as a foreign ministry official later
spoke of a wish to coordinate positively with India in our assistance efforts Pakistan sent
tents and a military hospital and Israel provided 95 tonnes of medical and other assistance
As for Nepalrsquos own government it faces huge challenges Rescue and immediate relief
operations are now making way for more sustained help for survivors Distributing materials
for proper shelter and ensuring good sanitation are urgent priorities before the monsoon
rains arrive in a couple of months The sowing season also starts soon so distributing seeds
and farm supplies is pressing
Jamie McGoldrick who leads the UN in Nepal worries that it is the most rural andremote
areas those where the poorestlowest-caste Nepalis live that are at risk ofneglect Though
the needs of the country sidersquos poor are greatest the lionrsquos share of foreign attention and aid
goes to Kathmandu home to the political elite the bulk of foreign workers and much of the
countryrsquos rich cultural heritage Mr McGoldrick also warns about weak governing capacity
He already sees bureaucratic rivalries as well as sloth as impediments to the countryrsquos relief
efforts Others point out that politicians have long been interested mainly in their own well-
being fruitlessly debating a new constitution for the past seven years while paying little
attention to governing
Effective local councils would surely be most useful administration to have in place now Yet
Nepal has had no local elections since 1999 Instead civil servants run things Many are
notorious for being unaccountable corrupt and prejudiced towards the lowest castes Donors
face a quandary wondering how much to trust questionable partners while rushing to help
Nepal has never been an easy place in which to make aid useful In this grievous emergency
it will be harder yet
22042015 Family companies To have and to hold | The Economist
httpwwweconomistcomnode21648171print 15
Special reportFamily companies
Family companies
To have and to holdFar from declining family firms will remain an important feature of globalcapitalism for the foreseeable future argues Adrian Wooldridge
Apr 18th 2015 | From the print edition
FAMILIES HAVE ALWAYS been at the heart of
business Family companies are among the
worldrsquos oldest The Hoshi Ryokan an inn in
Japan has been in the same family since 718
Kongo Gumi a Japanese family construction
firm was founded even earlier in 578 but went
bust in 2006 The Antinori family has been
producing wine in Tuscany since 1385 and the
Berettas have been making guns since 1526 Family companies played a starring role in the
development of capitalism think of the Barings or the Rothschilds in banking or the Fords and
Benzes in carmaking
Family companies are ideally suited to the early stages of capitalism They provided two of the
most important ingredients of growth trust and loyalty in a world where banking and legal
institutions were often rudimentary and poor communications made farshyflung activities hard to
control It was easier to raise money from kinsmen than from strangers And it was safer to send
a relative than a hired hand to expand the business abroad
Business enterprises also provided patriarchs with a way of transmitting wealth and status to
future generations ldquoThe bankerrsquos calling is hereditaryrdquo said Walter Bagehot a distinguished
19thshycentury editor of this newspaper ldquoThe credit of the bank descends from father to son this
inherited wealth brings inherited refinementrdquo Family dynamics sometimes dictated business
strategies the Rothschild bank helped to globalise finance when Mayer Amschel Rothschild the