Strategy: What an exchange! - Kotak

What an exchange! India has 'consumed' around US$300 bn worth of gold over FY2008-17 while FPIs have invested about US$124 bn in the Indian equity market over the same period. Gold prices have moved up 3X over FY2008-17 and so has the value of FPI holding. The next decade will perhaps decide the winner but we note that foreigners own large stakes in India's best companies. Meanwhile, the government's taxation policy on gold appears to be at odds with its financial inclusion and inflation policies.

Indians buy foreign gold and foreigners buy Indian equity

India imported and 'consumed' over US$300 bn worth of gold over FY2008-17 and financed the resultant trade deficit (gold contributed to trade deficits partly though) through large capital flows, some of which has gone into increased foreign ownership of Indian companies, now at almost 25% of the top-200 stocks. Gold prices have increased 3X in INR terms over this period but the 'trade' worked well over FY2008-12 with gold prices rising rapidly. However, FY2013-17 has seen half the gold 'consumption' of the past decade and virtually flat gold prices over this period.

Large gold imports reflect low confidence historically among Indians in government policies

The sharp increase in gold imports up to FY2013 reflect the Indian citizens' concerns about high inflation. It is interesting to note that the bulk of FPI inflows into India over the last decade took place in the years with high inflation. FPIs invested US$96 bn in FY2010-14 out of the total US$124 bn investment over FY2008-17 while India imported and consumed US$209 bn and US$190 bn worth of gold in FY2010-14 out of the total US$340 bn and US$300 bn of imports and net domestic consumption over FY2008-17.

India's taxation policy on gold at odds with its macroeconomic stability

We find India's GST rate of 3% at odds with the remarkable success achieved by the current government with respect to (1) financial inclusion and (2) inflation. We are quite surprised by the continued soft approach to and special status for gold at a time when gold's use as a 'store of value' is less relevant and as 'a store of black money' an anathema. (1) India's policy on inflation management has achieved remarkable success, which should reduce gold's function as a 'store of value'. (2) India's financial inclusion program has attained undeniable success and should reduce the compulsion of citizens to own gold as they have access to bank accounts. We have long argued for a proper taxation policy on gold to achieve the desired national goals.

The other exchange—an obelisk for a clock

In 1830, Khedive Muhammad Ali Pasha (viceroy of Egypt) gifted one of the two obelisks of the Luxor Temple (a marvel of the ancient world) to the French emperor Charles X. This beautiful obelisk (all of over 3,000 years old) now stands in the Place de la Concorde in Paris. In exchange, the French emperor Louis Philippe (successor to Charles X) gifted the Egyptian pasha a mechanical clock (a marvel of the modern world at that time), which can be seen in the Great Mosque of Muhammad Ali Pasha in Cairo. The clock has never worked reportedly.

Fun with FPI numbers

The value of FPI ownership of the BSE-200 Index stocks on March 31 for each of the past 10 years starting March 31, 2007. As can be seen, FPI investment has increased to US$368 bn as of March 31, 2017 from US$132 bn as of March 31, 2007.

We estimate that the value of FPI holding in the top-200 stocks by market capitalization (different from BSE-200 stocks; the top-200 stocks as of March 31, 2007 that have survived the last decade) was around US$130 bn as of March 31, 2007. The value of the same portfolio (no change in ownership) of stocks would have increased to about US$279 bn as of March 31, 2017. We note that the current value of FPI holding in the top-200 stocks (BSE-200 Index stocks) is US$368 bn. An analysis of the top-25 holdings of the FPIs shows that the increase in foreign ownership in certain companies has resulted in superior returns.

Lastly, it is interesting to note that FPIs own more than 50% in five of India's top-seven banks and financial institutions. It seems that foreigners have more faith in India's economy (banks are perhaps the most leveraged plays on the same) than Indians.

Source : Equity Bulls

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