Globalisation: Global issues, local problems

A year ago, we were all sitting pretty, projecting increasing corporate profits assuming that the dollar would be at around Rs45. We assumed that our economy would continue to be an attractive destination for foreign capital and that inflation would perhaps get tamed. The huge import bill did not appear a serious factor. But suddenly, the exchange rate has jumped from Rs45 to Rs54 (an increase of 20%) and I am not sure whether we should start looking at Rs60 over the next few years.

Suddenly, Indian companies with global exposure look vulnerable. Tata Steel had gobbled the much larger Corus. Now, we need special skills to forecast Tata Steel’s prospects because its operations, thanks to the acquisition, look complex. Borrowing in global currencies throws up another dimension. When we looked at IT companies, we were critical of companies with single-country exposure. Now, the entire globe seems to be contracting. A few companies are also staring at maturing foreign currency convertible bonds (FCCBs), which have no hope of getting converted into equity at the current low prices. This will push up their borrowing cost. Add to this, the efforts of the Reserve Bank of India (RBI) and the Institute of Chartered Accountants of India (ICAI) to ‘help’ Indian companies by diluting accounting standards, and it becomes impossible to decipher the accounts of many companies and banks. RBI seems to be doing its bit by putting ‘limits’ on foreign exchange dealings, laying the blame for the falling rupee on ‘speculators’.

In the era leading to the 1990s, as an analyst, one of the important factors for me in selecting companies was their vulnerability to imports and their ability to pass on imported inflation either through a weakening rupee or sheer domestic inflation. At the same time, we had to worry about import duties, import substitution, the ability of the promoter to ‘manage’ customs duty and tariffs, etc.

Gradually, we knocked the balance-of-payments issue out of our heads as the economy opened up, inflation started to moderate and tariffs started to come down. We also believed that, over time, the Indian rupee would perhaps stabilise, if not appreciate. A growing economy with increasing prosperity made us assume that the rupee would strengthen, but a look at the trade deficit tempered the optimism.

Now, we are faced with moderating growth, stubborn inflation and a global crisis that threatens to bring our foreign exchange problems to the forefront. Sure, we have $300 billion of reserves; but we also have a huge debt. What have been our saviours are the ‘remittances’ of Indians working overseas and ‘portfolio’ flows that (at various points in time) seemed inexhaustible and irreversible.

The old worries have resurfaced once again. In picking companies, I am worried about their global exposure. I am worried about the country’s foreign currency obligations. Surely, if there is a global contraction, Indian companies that are global are going to be hit. We also seem to think that a falling rupee is great for exporters. In reality, competition and bargaining power (of customers) bring down any super-normal gains. I am once again wary of companies (like infrastructure companies) that look to fund managers of FIIs (foreign institutional investors) to keep providing cheap equity.

So, for now, my preference in stock-picks is going desi. I would stick to companies that have low import intensity and cater primarily to domestic markets. Also, these are not great times for commodity stocks. If global trade shrinks, commodity prices will decline and inventory profits will vanish. I would look at companies with no- to low-leverage, fairly high return on net worth (RoNW) getting almost all their revenues from within the country. If a company does not meet these conditions, I will look at them only if I can get them at bargain prices. Bargain would mean dividend history, good businesses and available at maybe half of their book value. In good times, they should be able to deliver at least a 25% return on shareholder money. That is a must.

 

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