Rajen Gala

The Nifty 50 is a diversified 50 of the blue chip largest and liquid Indian companies listed on the National Stock Exchange, accounting for 13 sectors of the economy. Nifty 50 Index has an inception date of November 3, 1995. The index was constructed using a unique concept of impact cost, which helps in the selection of highly liquid stocks and results in the creation of a replicable index. The NIFTY 50 index is a free float market capitalisation weighted index. The index was initially calculated on a full market capitalisation methodology. On 26 June 2009, the computation was changed to a free-float methodology. It is used for a purpose such as benchmarking fund portfolios, index-based derivatives and index funds. NIFTY 50 is owned and managed by NSE Indices Limited. NSE Indices is India\’s specialised company focused upon the index as a core product. Derivatives Trading in call and put  options on the Nifty 50 are offered by the NSE. The exchange offers weekly as well as monthly expiry. Nifty Next 50 NIFTY Next 50, also called NIFTY Junior, is an index of 50 companies whose free float market capitalisation comes after that of the companies in NIFTY 50. NIFTY Next 50 constituents are thus potential candidates for future inclusion in NIFTY 50. Do you Know There are 12 companies who are part of Nifty 50 since inception. Across 25 years, there have been 101 inclusions in Nifty 50, averaging 4 per year. There are 7 ETFs based on Nifty 50 listed internationally having AUM of USD 1.07 Bn. Derivatives on Nifty 50 index are traded on 3 exchanges globally.  The flagship \’NIFTY 50\’ index is widely tracked and traded as the benchmark for Indian Capital Markets.  

There was a man named Hari who was taking a stroll when he came across a bunch of ragpickers. They were scanning through piles of garbage and waste. He realized they were searching for valuable stuff that sometimes accidently makes their way into the garbage. This practice of the ragpickers reminded him of a term in investing known as Bottom Fishing. If we look at the stock market, the stock market\’s health is largely dependent upon NEWS flow reflecting the state of the macro-economic environment. In other words, a good macro-economic environment leading to good and positive NEWS flow improves sentiments of investors. No investor would like to invest when the economic environment is not conducive because the risks of investing in adverse conditions are rather high. Let\’s say a country which had favorable political conditions, suddenly finds itself in the throes of terrorism. Under such circumstances the stock market plummets to a level that is commonly referred to as the bottom. At such times, the stock prices of perfectly healthy and robust companies also tend to test the bottom. The sentiments are so discouraging that everything is viewed from the same pessimistic lens and all companies good and bad get painted by the same gloomy and gray brush. However, such are times that present the best opportunities to astute investors. There are opportunities to identify stocks that are quoting at prices below their intrinsic values. Such under-valued stocks can yield handsome returns when the negativity in the macro-economic environment alleviates. Identifying such valuable stocks in what is popularly known as Bottom Fishing which translates to fishing for good companies when the markets bottom out. It helps investors generate meaningful returns while containing the risks. Buying undervalued assets brings in a good margin of safety, making it a very successful strategy for investors. Risks of Bottom Fishing Though bottom fishing can be extremely rewarding, it does carry risks as not always the beaten-down assets return to their perceived intrinsic value. The assets may also decline further in price, damaging the investors capital. When the damage to the price of the asset is irreparable, it keeps on declining in price and never comes back to the investor’s buying price. In some asset classes like stocks and bonds, investments may lose all of their value, leaving the investors with damaged merchandise. Such investment decisions might end up risking the entire returns of the portfolio.  

Stagflation is characterized by slow economic growth and relatively high unemployment or economic stagnation, which is at the same time accompanied by inflation. Stagflation is a period of rising inflation but falling output and rising unemployment. Stagflation is often a period of falling real incomes as wages struggle to keep up with rising prices. A degree of stagflation occurred in 2008, following the rise in the price of oil and the start of the global recession during the collapse of Lehman Brothers. Stagflation is difficult for policy makers. For example, the Reserve Bank can increase interest rates to reduce inflation or cut interest rates to reduce unemployment. But, they can’t tackle both inflation and unemployment at the same time. Causes of Stagflation When Oil price rises it causes a rise in business costs, transport will become more expensive and short run aggregate supply will shift to the left. This causes a higher inflation rate and lower GDP. If trade unions have strong bargaining power they may be able to bargain for higher wages, even in periods of lower economic growth. Higher wages are a significant cause of inflation. If an economy experiences falling productivity, workers becoming more inefficient; costs will rise and output fall. If there is a decline in traditional industries, we may get more structural unemployment and lower output. Thus we can get higher unemployment, even if inflation is also increasing. If there is disruption to supply chains, there prices will start rising. The supply shock will also cause decrease in unemployment. Moderate stagflation People may talk about stagflation if there is a rise in inflation and a fall in the growth rate (i.e. the economy is growing at a slower rate. This is less damaging than higher inflation and negative growth. But, it still represents a deterioration in the trade-off between unemployment and inflation. Currently, inflation is very high, and economists are worried about economic growth because of the war in Ukraine as well as lockdowns in China and supply chain disruptions related to the Covid-19 pandemic. Are we in a period of stagflation now? Not necessarily. According to the ministry of statistics and programm implementation, India\’s FY22 GDP growth is likely to be 8.9 percent this year. We are not in a situation of stagflation as of now. The growth may come down from whatever was being projected earlier, but it is still likely to be closer to 7 odd percent. Expectation is highly on manufacturing seeing bigger share in GDP in India and even we can expect India to gain market share in global goods exports so that it is not just dependent on the global beta of trade growth improving, but it gets the alpha of increasing market share in global goods exports.

The Reserve Bank of India mandates that banks store a proportion of their deposits in the form of cash so that the same can be given to the bank’s customers if the need arises. The percentage of cash required to be kept in reserves, vis-a-vis a bank’s total deposits, is called the Cash Reserve Ratio. The cash reserve is either stored in the bank’s vault or is sent to the RBI. Banks do not get any interest on the money that is with the RBI under the CRR requirements. Cash Reserve is a  bank regulation that sets the minimum reserves each bank must hold by way of customer deposits and notes. These deposits are designed to satisfy cash withdrawal demands of customers. Cash Reserve Ratio is also called the Liquidity Ratio as it seeks to control money supply in the economy.  Effects on money supply… CRR is used as a tool in monetary policy, influencing the country’s economy, borrowing and interest rates. CRR works like brakes on the economy’s money supply. CRR requirements affect the potential of the banking system to create higher or lower money supply. Let us now understand how CRR requirements affects the potential of banks to ‘create’ higher or lower money supply. CRR and liquidity… For e.g. say…the CRR is pegged by RBI at 10%. if a bank receives 100 as deposit, then they can lend Rs.90 as a loan and will have to keep the balance Rs.10 in customer’s deposit account. Now, the borrower who has received Rs.90 as a loan will deposit the same in his bank. The borrower’s bank will now lend out Rs.81 (Rs.90 X 90%) and keep Rs.9 in his deposit account. As this process continues, the banking system can expand the initial deposit of Rs.100 into a maximum of Rs. 1000 (Rs.100 + Rs.90 + Rs.81…= Rs.1000)  Similarly… For e.g. say…the CRR is pegged by RBI at 20%. if a bank receives Rs. 100 as deposit, then they can lend Rs.80 as a loan and will have to keep the balance Rs.20 in customer’s deposit account. Now, the borrower who has received Rs.80 as a loan will deposit the same in his bank. The borrower’s bank will now lend out Rs.64 (Rs. 80 X 80%) and keep Rs.16 in his deposit account. As this process continues, the banking system can expand the initial deposit of Rs.100 into a maximum of Rs. 500 (Rs.100 + Rs.80 + Rs.64….=Rs.500) So… The higher the cash reserve (CRR) required, the lower the money available for lending. Every time the borrowed money comes into a deposit account of a customer, the bank has to compulsorily keep a part of it as reserves. This reduces credit expansion by controlling the amount of money that goes out by way of loans. This directly affects money creation process and in turn affects the economic activity. Hence central banks in the world increase the requirement of cash reserves whenever they feel the need to control money supply. To sum it up… CRR is increased to bring down inflation which happens due to excessive spending power. Spending power is augmented by loans – if money that goes out as loans is controlled, inflation can be tamed to some extent. Conversely, if the government wants to stimulate higher economic activity and encourage higher spending to achieve economic growth, they will lower CRR. A lower CRR allows the bank to lend more money and will fuel consumption and spending. Thus, banks indirectly enjoy the power to create more money. The Cash Reserve Ratio in India is decided by RBI’s Monetary Policy Committee in the periodic Monetary and Credit Policy. The Reserve Bank of India takes stock of the CRR in every monetary policy review, which, at present, is conducted every six weeks. CRR is one of the major weapons in the RBI’s arsenal  that allows it to maintain a desired level of inflation, control the money supply, and also liquidity in the economy.

The difference between total revenue and total expenditure of the government is termed as fiscal deficit. It is an indication of the total borrowings needed by the government. While calculating the total revenue, borrowings are not included. The government needs money for its huge expenses. We can broadly divide government expenses into two types: Revenue expenses Capital expenses The money spent by the government for paying salary to its staff is revenue expense and the money spent for constructing a hospital is capital expense. So how does the govt. meet these expenses? The government finances its expenses by Revenue by direct and indirect taxes Revenue by non-tax means include Revenue receipts: These include dividends received from public sector companies, fees, fines, forfeitures etc. Capital receipts: These include sale of PSUs, recovery of loans, borrowings of the government. Revenue receipts are recurring in nature like the salary you earn while capital receipts are occasional in-flows like the proceeds you may receive on selling your house. So where is the deficit? The expenses that the government incurs is always more than the income it makes. This difference or deficit is known as “Fiscal Deficit”. It is expressed as a percentage of GDP. The financing of this deficit is known as “deficit financing”  So how is this deficit financed? Through government borrowings. It is due to this reason we had included borrowings of the government as revenue in one of our earlier slides. OR Through printing of additional currency notes.  Which is a better option then? Borrowing money from the market is a better option because if the government were to print more notes it would increase supply of money in the economy thereby reducing its “buying power” and causing inflation. Inflation would hurt one and all making the government un-popular. Therefore, borrowing from the market is a better option as it does not alter money supply. But this too cannot go on endlessly. Government borrowings too have a limit. Borrowing money from the market cannot be an endless strategy purely because there is limited money in the market and needs to be made available for other borrowers as well. Too much of borrowings will drive up interest rates making credit expensive and thereby putting pressure on prices. Hence, the only way to control the deficit in the long run is by spending less and earning more.