Dear clients, my apologies for not presenting my monthly blog for 30-Nov-16. We have been swamped with work including the revamping of our website, change in office location and the move to the MFUTILITY platform for mutual fund transactions in the DIRECT mode. In the midst of all this, client acquisition has been active.

There has been a flurry of articles written on the recent demonetization move of the Government of India. The commentary made can broadly be classified under a) motive, b) practical ground situation c) implications for the economy and businesses. I would like to present my views on the demonetization move through the lens of these points.

Whether the motive was the eradication of black money and counterfeit currency, whether going cashless, whether senior most ministers in the cabinet were consulted or not, or as the opposition accuses, whether this was done at the behest of certain interested parties, is uncertain and not wise to speculate upon. What we do know is that the Prime Minister has made this about himself. In my view the Prime Minister has risked enough and has enough to lose – the next election and probably more, if this move back fires and from that sense at-least it passes the test of motive. In any case, dwelling upon motive is probably irrelevant to how we can respond to the circumstances that are playing out as we speak.

As time and again proven, top down decision making in complex environments is ridden with enough uncertainties that it is wise to remain a skeptic. As some one was recently telling me in a conversation, a handful of men at the top are working overtime to outsmart a billion and a half people. Who do you think is going to come out tops ? As is clear and news articles have made evident, large scale leaks in the banking system, unscrupulous middle men, government officials - all with very little to lose, have made a mockery of the so called controlled release of new notes into the hands of the Indian public. It is clear that good intentions are not enough. Practical ground realities show a picture in complete contrast to the pristine black and white scenarios, that I am sure would have been conjured up by the mandarins in New Delhi. From this perspective the move has been a disaster and at-least in the short run seems to be rendered a pretty blunt instrument for its original stated objective of eradicating black money.

I must state however, that this has provided an opportunity to reset from the perspective of going cashless. While unlikely to have been the original intention of the move, I believe the middle class Indian today is significantly more open to the idea of a cashless transaction than he was probably about a month and half ago. We have a momentum going and hopefully this can be built upon. As is evident over the past six weeks, large-scale contraction in businesses has been coming to light. In addition to the severe restriction on withdrawals, the cornering of large amounts of the newly issued notes by a handful few who have hoarded up, has made cash, which greased the system, to disappear, bringing the Indian economic engine to a sputtering halt (read Ambit report). There is a thesis going around, also highlighted in the Ambit report that a structural shift from unorganized tax evading players to tax paying organized players is likely. There may be some merit to this point, but then as always the truth is likely to be a grey middle. Nimble, unorganized and tax evading players are not likely to sit around twiddling their thumbs. I would desist from making some large-scale assumptions on which businesses are going to gain and which are not. I would as always continue to evaluate businesses on their merit i.e. the ability to capture market value rather than market share, the capital allocation skills of its managers, the promoter’s skin in the game, the presence of non-linear opportunities for the business and of course a reasonable share price. So to me it is business as usual as far as stock picking is concerned.

With demonetization in play, I believe there is some more room for interest rates in the wider economy to go down. With a higher proportion of low cost funds in the formal banking system, and persistent efforts over time to channel savings into the formal financial sector, there is a likelihood that cost of debt capital in the economy is likely to reduce further. This presents in my opinion a window of opportunity to make continued capital gains on long duration bonds. How long this opportunity lasts is anybody’s guess. Many of you may thus have noticed that since demonetization, we have increased our exposure to long duration bonds. With the cost of debt capital reducing, overall cost of capital in the economy is likely to come down, and this can provide some cushion to stock valuations. However, this cushion gets offset by the likely contraction businesses are going to experience, and the negative implications for growth that it means.

The demon in demonetization is in the details. With so much complexity, prediction is a hazard best avoided. It is as always prudent to have an empirical approach rather than a predictive one. Having optionality (cash) and opportunistically deploying investment funds in small amounts is to my mind a wise approach and particularly applicable at these times.

Wishing you all a very happy 2017 !!