Monetary Policy Committee: Both the Government and RBI have got it wrong

With the RBI and Government tugging at extremes, the middle ground is better

 RBI Watch                                                                                    Monetary Policy 2015-16

I had written on this subject on October 22, 2014. Please read this blog to get the full picture.

I place below the relevant section.

"What should be the process for deciding the course of monetary policy?

The Urjit Patel Committee suggested moving the responsibility from the Governor of the RBI to a Monetary Policy Committee (MPC). This makes sense.

The Committee suggested that the MPC should consist of the Governor, a Deputy Governor, an Executive Director of RBI, and two external members picked by the RBI. My view is that to start with, we need a small MPC of four members consisting equally of internal and external members. I suggest two external members, both persons of independent standing with experience in fields such as of banking, finance, industry (agriculture or manufacturing) and sociology. Government should pick these members in consultation with the Governor.  The two internal members will be the Governor and a Deputy Governor in charge of monetary policy at the RBI. In the event of a tie, the Governor should cast one additional vote.”

Last week the government released a revised version of the draft Indian Financial Code. Clause 256 page 122 covers the detail regarding the composition and voting by members of the MPC. The clause indicates that the MPC would consist of seven members - four appointed by Government and three from the RBI. The MPC will determine the policy rate by majority vote.

I hold to my view, which is that the MPC should consist of an equal number of members from within and outside the RBI. 

Why should the RBI have a majority in the MPC? Surely, there are people with expertise outside the RBI on monetary policy, and it makes for better decision making if such members are equally represented on the MPC. On the flip side, what justification does government have for the MPC to have a majority of government appointed members? I do not see any grounds for this, irrespective of the yardstick that is used – expertise or responsibility. It is the MPC's function and not the government's to set the policy rate.

I do believe, at this juncture, that the Governor (the IFC refers to a new title: chairperson!) of the RBI should be given an enhanced power to cast an additional vote in case of a tie in the votes, i.e all four members vote, and should there be a tie, then the Governor casts his additional vote.

Why? The intricacies of inflation targeting is in its infancy in India, the concept of an independent committee setting interest rates is yet to be institutionalised, and expertise in both monetary policy and markets is scarce to find. In this scenario, I would argue that the Governor, an individual picked for his/her superior expertise on monetary matters and professional integrity – whose performance, all said and done, will be judged by whether he or she achieves the inflation target, although it is the MPC which is formally responsible - should be given an enhanced voting power at the MPC. 

Can the same argument not be used to give the Governor the power of veto? I believe this is not the right governance in a public institution of high standing consisting of experts. If the Governor is in a minority in one particular round of voting at the MPC, then it is only fair for the Governor to accept his position.

A further look at company level information on margin funding on the NSE: will margin funded investors get it right on Suzlon this time?

Indian Stock Market Watch

I thought I would dig a little deeper into margin trading with data at a stock level released by the National Stock Exchange (India’s dominant exchange). In this context, please refer to my blog of July 7 titled “Margin trading investors seem less enthusiastic with the current bull market, which showed the current level of margin funding by brokers and its trend over the last ten years, using NSE data.                                                              

As of the end of last month, June 30, 2015, the five companies in which investors were most heavily invested using margin funding on the NSE are shown below.

Three of these are large caps - SBI, ICICI and Tech Mahindra. Suzlon is a mid cap, and Raj TV, is a small cap. SBI has consistently ranked number one for most of the period since the start of 2011. Raj TV is an interesting one. But I have little knowledge about this company, and so I will not even start thinking about why investors would want to leverage and buy this stock.

As I have been following Suzlon and am a cash investor in Suzlon, my focus will be on this stock. For the majority of time since 2011 it has been among the top twenty stocks leveraged by investors using margin funding.  Yet it is a stock that fell in price by 85% in value since the start of 2011, and only since mid 2013 has rebounded in value to the current level of 22, but is still 50% below its price in January 2011!

The graph below compares the stock price of Suzlon with the margin funding outstanding.

The picture above suggests that a set of investors using margin funding have been consistently positive on Suzlon - their exposure to Suzlon did fall as the share price fell, but after taking a break in the second half of 2014, they once again took to investing in Suzlon.

The graph below compares the share price with the rank of Suzlon among the top margin funded stocks.

Apart from a nine month period from July 2013, Suzlon has ranked among the top twenty stocks traded using margin debt. 

A look at NSE data for the last week ended July 17, 2015 showed that Suzlon's position was first!

Suzlon is a company that got just about everything wrong since 2007: overexpansion, excess borrowing and a nasty external environment after the financial crisis of 2008 was followed by part default, debt restructuring, lack of working capital, and shrinking sales. 

However, over the last one year the company seems to have put the building blocks of its survival and growth in place: Suzlon,with no other option, sold its prize asset, Senvion, to pay off long term debt, converted some debt into equity, brought on board Dilip Sanghvi, the promoter of Sun Pharma, arguably India's most successful pharma company as a significant investor, and refocussed its strategy on the Indian market.

This time around it looks like margin funded investors in Suzlon stock may have got it right.

The value of the Rupee: monthly update

RBI Watch                                                                                               Indian Rupee 

Margin trading investors seem less enthusiastic with the current bull market

Indian Stock Market Watch

Some investors borrow funds to buy equities. This is called buying on margin, where the investor puts some of his own funds (typically 50%) and borrows an amount (generally an amount equal to his own funds) from the broker to invest in equities. Margin enables the investor – either short term or long term – to increase his or her exposure to the market. A commonly used term for this is leverage.  Margin funding is generally considered a barometer of the bullishness of investors on the market.

I have been looking at the data on margin funding of investors by brokers on the National Stock Exchange (NSE), the predominant stock exchange in India. . Bombay Stock Exchange data is also available, but I have chosen to ignore it since currently margin funding by its members is just 1-2% of funding by NSE members.

The graph below gives the picture since 2005. On the same graph I have juxtaposed the performance of the Niftyfifty,a closely followed index of the Indian stock market.

The level of margin funding – total outstanding at the end of a month - extended by its members on the NSE has risen to 69 crores as at end of June 2015 from Rs 54 crores a year ago. But this is nowhere close to the last two peaks – Rs. 270 crores at the end of January 2008, and later Rs 318 crores in 2010 at the end of September 2010. Both these peaks coincided roughly with bull runs in the market as can be seen from Niftyfifty graph. Yet, in the recent bull run that accelerated after the Modi government came to power funding for margin trading has hardly recovered!

The graph below shows both margin funding and total turnover of the cash market on the NSE. From 2013, the market’s turnover has increased and has now averaged in excess of Rs 20,000 crores during the last one year – similar to the peaks seen in the last two bull runs ending in 2008 and 2010. The ratio of margin funding as percentage of market turnover has therefore fallen to just 0.4% as of the end of June this year compared to previous highs of just over 2% during the bull runs that ended in 2008 and 2010.

Does this tell us something about the future of the current bull run? If we assume that investors who trade on margin are different from the average investor – either they could be more savvy and/or obviously greater risk takers  - then it appears this time round they have much less enthusiasm for the current bull run which started in 2012, and picked up pace after the Modi government came to power. They could be right or just dead wrong. Either way, I propose to keep a watch on the trends in margin trading.

Alternatively, could it be that the investors who trade on margin are now borrowing not just from stock brokers but also from banks and NBFCs? I don’t have the answer to that because my research indicates that such disaggregated data is not available.

Monitoring the NaMo Bull Market in Stocks: Update as of June 2015

Indian Stock Market Watch

Please refer to my blog of July 9, 2014 for the original note on using TMV/GNP ratio to gauge whether the market  is cheap or expensive.