Stock Markets Unmoved By The Middle East War
The stock markets in India and elsewhere seem to be largely resisting any panic responses arising from war in the Middle East
On Episode 614 of The Core Report, financial journalist Govindraj Ethiraj talks to Amit Tandon, Founder and Managing Director at IiAS.
SHOW NOTES
(00:00) Stories of the Day
(01:09) Stock Markets unmoved by the Middle East war, for now. Iran launches missiles at Qatar
(03:57) The rupee turns weak as the dollar strengthens
(06:15) Oil prices recover from a steep drop as traders look at supply impact
(10:52) Oman to become first Gulf country to charge Income Tax in sign of changing times
(12:00) India’s promoter led companies control their fate and fortune in more ways than one
NOTE: This transcript contains the host's monologue and includes interview transcripts by a machine. Human eyes have gone through the script but there might still be errors in some of the text, so please refer to the audio in case you need to clarify any part. If you want to get in touch regarding any feedback, you can drop us a message on [email protected].
—
Good morning, it's Tuesday the 24th of June and this is Govindraj Ethiraj broadcasting and streaming weekdays from Mumbai, India's financial capital, but in transit right now, so you will find my voice somewhat strained as I'm in a slightly open place and recording.
So, our top stories and themes before we move on.
The stock markets are unmoved at this point by the Middle East war for now, but Iran has launched missiles at Qatar and the United Arab Emirates had shut airspace as of Monday night.
The rupee turns weak as the dollar strengthens
Oil prices recover from a steep drop as traders look at supply impact
Oman to become the first Gulf country to charge income tax in a sign of changing times,
And India's promoter-led companies control their fate and fortune in more ways than one.
The Markets Hold On
The stock markets in India and elsewhere seem to be largely resisting any panic responses arising from war in the Middle East for now, as largely expected.
However, as we know now, Iran has launched missiles against Qatar, which is really a second order impact of the original bombing of Iranian nuclear facilities by the United States. So, we really don't know how things will evolve from here, at least at this point. From a market's point of view, the concern has always been for the last day or so, how Iran will retaliate if it does, which of course brings in the uncertainty over a longer period of time.
But the important indicators to watch in the coming days will be the rupee and oil prices, both of which are under pressure already. While the oil markets are computing the impact on oil prices based supply from Iran into the global market, the question is what happens if Iran shuts the Straits of Hormuz as it's already taken some preliminary steps towards, and more on that shortly. So, on Monday, the major indices closed the trading session lower as investors analysed the potential impact of the United States joining the Israel-Iran war by bombing those three nuclear facilities in Iran.
In a day of choppy trade, the Sensex was down 511 points to close at 81,896, and the NSE Nifty 50 was also down about 140 points to close at 24,971. Now, interestingly, the broader markets did much better, closing in the positive with the Nifty mid-cap 100 and small-cap 100 indices closing higher by 0.36 and 0.7% respectively. So, foreign institutional investors were net buyers on Monday, continuing a trend for the last few days, even as domestic institutions were selling.
Some sector-specific news, the stock markets were watching IT giant Accenture's results, which reported the first signs of client nervousness, according to Business Standard, during its latest results. Now, Accenture is a bellwether of sorts for Indian IT companies and reported last week a third-quarter FI2425 revenue of $17.7 or close to $18 billion, which was up 7% year-on-year in local currency or constant currency and about 7.7% in US dollar terms. Now, here's the interesting part.
The consulting giant's deal bookings were down about 6.5% year-on-year to about $20 billion, and consulting bookings were also down about 2.2%. So, on Wall Street, stocks were higher on Monday, even as the Dow Jones Industrial Average was up 90 points and the S&P 500 and the Nasdaq Composite were trading higher. Meanwhile, the dollar index was up nearly 0.4% as Safehaven Investing picked up to touch a near two-week high of 99.4, while Asian currencies, including the rupee, were down between 0.2% and 1.4%. ING Bank, in a note reported by Reuters, said that in case the geopolitical risk and oil spike proves to be only temporary, we think markets will rapidly default back to the preferring strategic USD shorts on the back of US-generated bearish drivers. Now, the rupee, which took a hit, closed 16 paise lower against the dollar at 86.75 rupees, which was slightly down compared to its previous closing level of 86.58 rupees.
Meanwhile, the Indian rupee's decline against the dollar is pushing it closer to a critical threshold, raising expectations that the Reserve Bank of India may step in to stabilise the currency as global tensions mount, according to a Bloomberg report. Now, the Reserve Bank of India is likely to intervene if the rupee weakens further towards 87 rupees a dollar, according to the Australia and New Zealand Banking Group and the MUFG Bank Limited, reported by Bloomberg. The rupee is the worst-hit Asian currency this quarter, thanks to rising oil prices.
Now, while most emerging market currencies have come under pressure since tensions flared up between Iran and Israel this month, the rupee is particularly vulnerable. India is the world's third-largest importer of crude oil, and rising prices put an upward pressure on its current account deficit and inflation outlook, according to that report. A currency strategist at ANZ said that the 87 level is very much on the cards if the Middle East tensions rise and the crisis becomes a regional one, which it does look like it's becoming, and the Reserve Bank of India will not be comfortable with anything beyond 87 rupees per dollar.
Among some positive news, India's economic activity picked up in June, thanks to a surge in new export orders that boosted the manufacturing sector, according to a flash survey by HSBC Holdings. The Manufacturing Purchasing Manager's Index of PMI, as we call it, rose to 58.4 from 57.6 in May, while the Services Purchasing Manager's Index climbed to 60.7 from 58.8 last month. All of this helped the composite index jump to 61 compared to 59 in May.
So these reflect business confidence in the economy and are based on preliminary surveys. The data could be revised when final PMI figures are released next month, and a reading above 50 indicates expansion in economic activity, while a number below indicates contraction, according to reports.
Oil Whipsaws
Brent crude oil futures hit a five-month peak of $81.40 a barrel earlier on Monday but pulled back to about $77 per barrel. Iran has repeatedly threatened to retaliate after the US struck the country's nuclear sites over the weekend and has now done so.
There are also continued fears that a closure of the Straits of Hormuz, through which roughly a fifth of global crude supply flows could have a wide-ranging impact. Oil prices have been zooming since Israel attacked Iran more than a week ago, with crude benchmarks pushing higher, options volumes spiking, and the futures curve shifting to reflect fears of a near-term interruption to supplies, according to Bloomberg, which also said that the Middle East accounts for about a third of global crude production. Though there have not been any signs of disruption to physical oil flows, including for cargoes going through the Strait of Hormuz chokepoint.
An analyst at Rapidan Energy Advisors and a former White House energy official told Bloomberg that we are up $10 a barrel since the war started, now a little more, and so I think there is an appropriate amount of risk in the market. While the war risk seems already priced into the current oil prices, the biggest or the bigger crude risk is physical if Iran closes the Straits of Hormuz, through which, as we said, about 20 percent of the world's crude output passes through. Two supertankers U-turned from the Strait on Sunday before subsequently resuming on their original course and transiting the chokepoint.
Bloomberg also says that since Israeli attacks began earlier this month, there have been signs that Iranian oil flows out of the Gulf have risen rather than declined.
The India View
So what is the macro view from an India point of view? So let's see what people are saying about the impact of high crude prices since that's more direct and visible.
A note from Elara Securities says Brent higher by about $10 a barrel could mean a higher trade deficit by 20 to 30 basis points as a percentage of GDP. Bank of Baroda Research says that in the past higher prices have been absorbed by the government and oil marketing companies while lower prices have not been passed on. Assuming the same happens, there could be or would be minimal impact at the petrol pump.
Elara Securities also says that with overall food prices remaining benign and India's service exports still solid, the outlook for both inflation and trade remains manageable. That is, of course, if the Straits of Hormuz don't close. Though they point out, as others have, that a blockade of the Straits of Hormuz would be self-defeating for Iran and throws, of course, huge challenges to Asia's energy, particularly China and their supply in upcoming quarters.
And this would, of course, escalate the whole conflict and the role of the Middle East in it. Meanwhile, India is importing more from Russia and at two-year highs now, much more than what we import from Iraq, Saudi Arabia, the United Arab Emirates and Kuwait. We also import from the United States, as we've mentioned here in the past.
A BoB research note also says that higher prices of oil will affect the import bill for sure, and around 25% of imports in the last year were from this basket. But export of petroleum products, which are significant with a share of about 15%, so the net impact would be about 0.25 to 0.3% of GDP, with the trade deficit widening by about $12 billion. But then the BoB research report also points out that India's service exports are strong and therefore the impact on current account deficit would not be that significant.
There is, of course, some discussion on whether the higher prices will affect wholesale prices and how that could affect monetary policy stance, but it's our belief, at least at the core report, that we could cross that bridge a little later, depending on how or where oil prices land up. Meanwhile, there seems to be more impact on the agricultural side. Newspaper Mint is reporting that nearly 100,000 tonnes of basmati shipments bound for Iran are stranded at Indian ports, as exporters have put deliveries on hold amidst a growing uncertainty.
Iran imports nearly 1 million tonnes of basmati rice from India annually, accounting for about 20% of India's total basmati rice exports, according to the All India Rice Exporters Association. According to them, about 1,500 crore rupees of payments due to Indian exporters are stuck amidst this conflict, and they worry about the impact that this will have on exporters. Meanwhile, direct sugar exports to Iran are limited, but India routes shipments to Afghanistan through Bandar Abbas due to its fraught trade relations with Pakistan, and operations at the port are currently stable, but any escalation could disrupt sugar movement to Afghanistan, according to an industry spokesperson who spoke to Mint.
Oman Income Tax
Oman has announced plans to impose income tax, becoming the first Gulf state to do so in an effort to broaden its sources of public revenue beyond oil, as other emirates have also done. The 5% levy will not take effect until 2028 and only applies to annual income of $109,000, or above, Bloomberg quoted state-run Omani news agency saying on Sunday, which means only the top 1% of earners will have to pay the tax. The Minister of Economy said the measure would reduce reliance on oil incomes by diversifying public revenue while maintaining social spending, so no country in the oil and gas-rich Gulf Cooperation Council, which has six members, has income tax.
For countries like Saudi Arabia, the United Arab Emirates and Qatar, that's a big draw for foreign workers, and obviously what Oman is doing will be watched by the others. The chief economist of Abu Dhabi Commercial Bank told Bloomberg that while the scope is narrow, it will still be a significant fiscal development in the region and it could act as a catalyst to other GCC countries implementing the tax in future as well.
The Promoters Stranglehold
Institutional ownership in companies is increasing, but with promoters continuing to hold a majority stake in most companies, they are able to exercise significant control over voting outcomes in shareholder meetings, according to a report by the Institutional Investor Advisory Services, a proxy advisory firm.
In the report, Shareholder Meetings Review for 2024, IIAS analysed shareholder meetings for the nifty 500 companies, with a focus on voting behaviour and evolving corporate governance practices. The report said that the promoters' dominant shareholding, combined with consistently high participation in voting, often results in outcomes that favour their interests. And they also say that since August 2011, their data shows that only one in every 200 resolutions has been defeated, which obviously reflects the outsized influence of promoter ownership.
The report said that a total of 1,057 shareholder meetings were held, where 4,840 resolutions were put to vote in 2024. The resolution categories, that's Director Appointment, Adoption of Accounts, Remuneration and Compensation, Dividend Distribution, and Auditor Appointments and Reappointments, accounted for about 71% of all resolutions. Companies concerned in this sample, in no particular order, are Fenelix Cables, Adani Ports, Interglobe Aviation, Indigo, Root Mobile, and RITS.
So I reached out to Amit Tandon, Managing Director of IIAS, and I asked him about the concerns, in a broader sense, that were expressed in the report, and more importantly, what could be done to address them and safeguard investor interest.
INTERVIEW TRANSCRIPT
Amit Tandon: This is the fourth such study we've done. So we've kind of now got some kind of data over the last five, six years. But there are a couple of things which stand out.
The first is the ownership pattern. Now what we've done for the purposes of this study is counting each share. There is a little bit of difference when you are looking at the market cap versus when you're counting each share.
And what we find is institutional ownership, which stands at about a little over 50% when you're looking at the market cap. You know, there's some differences, not so much as far as the promoters are concerned, which are at roughly 50-51%. But as far as institutional investors are concerned, if you weigh the data by market cap, they own about 35% of the equity.
And if you look at it in terms of each share owned, they're at 27%. And conversely, the retail and other investors are at 22% for each share owned versus 15% if you weigh it by market cap. And it just shows that the institutional investors have been investing in the stocks, which have kind of done a little bit better.
And they kind of seem to be in the right shares. The second is if you kind of break it up into different sets of data. So SEBI asks companies to report voting by promoters, by institutional shareholders, and by others.
If you look at promoters, one of the interesting factors over the last three years is that the promoter vote is actually coming down. And this is primarily because of the fact that there are a lot of transactions, which majority of minority transactions where they don't get to vote. And the second is you've got an increasing number of institutionally owned companies, which don't have an identifiable promoter group.
So if you go back about 8-10 years, you would say that it is L&T, ICICI, HDFC. That number has kind of slowly gone up. It's at about 27-28.
My sense is over the next three years, this number will again double from where it is. The other fact is that institutional shareholders have been voting in larger numbers, though the average vote is kind of stuck at about 80%. If you look at the median, it's kind of 86-87%.
And that is going up. The persons who are not voting are what SEBI calls others. That includes retail investors, corporate bodies, so on and so forth.
There's a list of about 27 of them who kind of vote about 21% of their shares. So that is how it stacks up. Interestingly, pretty much everyone is voting 95% of their shares.
I mean, promoters are almost 100% of their shares or unless there is some intra-promoter feud on, institutions are about 96% for and others are about 99% for. So the overwhelming vote is for, which is why when you see a resolution which does not go through, it kind of hits the headlines with a number of newspapers and a number of social sites. So just to give you a sense, we would have looked at about 7,500-odd resolutions of which 24 were defeated this year.
Again, if you look at resolutions which are defeated, it's a mix. It could be alteration of charter document, it could be director appointment, it could be related party transactions, it could be compensation. So it's not just one item which shareholders are voting against, which shows that they're a little bit thoughtful in terms of how they are voting.
Govindraj Ethiraj: So if you were to look at the highest shareholder descent and the table that you've compiled, I can see companies like Finalex Cables, even Nestle India. So Nestle seems to be a bit of a standout there. And the outcome is that it was rejected, which I guess happens in many cases.
So what is the takeaway from that in terms of the kind of companies where, let's say, there is a certain institutional position as institutional investors and the outcome of it?
Amit Tandon: So, Govind, I think there are a few things which stand out for institutional investors. So while we have seen SEBIs focus a lot on related party transactions, related party transactions for whatever reason are not such a big issue with institutional investors. And maybe this is just because of the construct.
If you look at some of the businesses, if you look at something like Hyundai came up with a public issue and has had a lot of related party transactions for which they sought shareholder approvals. But if you look at the structure of the auto industry, it is that you've got a bunch of suppliers. The auto manufacturer typically might hold some equity in it so that there is a closer linkage.
And therefore, they're buying from them. And the market has come to accept it. The second is that just in terms of a historical context, you look at someone like the Tatas.
You've got Tata Steel, which is manufacturing, but you've got Tata Power, which is kind of supplying power or managing the power. So investors are, by and large, OK. They do have concerns when there are adjacencies which can't be explained or dependencies which are built up, which is to say that, look, you've got the family, which is kind of becoming the supplier.
You're routing the exports through one of the family-owned concerns or you're buying raw materials through a family-owned concern, et cetera. Those are the dependencies. And that is where the investors have a big issue.
But if you were to leave aside those, the two or three areas in which investors do have pushback to companies, one is ESOPs. And that is primarily because they want to see an alignment of interest. So if they're buying shares at 100 rupees, they expect that the employees will also be given shares at or close to 100 rupees if it's at a steep discount.
They don't see that alignment of interest. And this is going to be a big problem because companies see it as deferred compensation. Investors see it as pay at risk.
And therefore, how do you bridge the gap? And that's one of the issues which we've looked at and are working with and trying to find a solution. The other is compensation.
If you, again, look at compensation resolutions, what we find is that if you go back five, six years, compensation wasn't a big issue in the Indian market. But pretty much after the pandemic, what you find is the compensation has grown faster than both the top line and the bottom line, at least for the largest 500 companies. And therefore, that is becoming a big challenge.
The third is special rights, which are built into the articles of association, which says that there is a private equity firm which will have seats on the board. And that happens irrespective of their ownership percentage. Or you say that the promoter has special rights, which get embedded in the articles of association.
So those are, again, an area where investors, we see a high degree of dissent. Having said so, there could be specific instances. You pointed out Nestle, there was an issue with the royalty payment, where, again, while there is some genuineness or there is a need to pay royalty, investors want to see a closer alignment and a better explanation in terms of why is it that the royalty agreement is changing now.
Is the company going to bring in more products? Are they bringing in newer technology? That needs to be explained a lot more clearly, which is why we saw the outcome which we did in Nestle.
Govindraj Ethiraj: And I think that's a useful indicator as well as to what the kind of questions investors should be asking and where they should be asking. And some would be more granular and some would be more evident and apparent, like in some of the companies where, let's say, there's a promoter feud going on, or there is director compensation involved, where it's, I mean, I guess it's much more tangible. Let me ask a slightly different question.
So when you look at institutional investors, they're already, let's say, empowered with more information and maybe even information gathered over time to make decisions like this, which is to work with, let's say, an IIS to figure out what stance to take and so on. Let's say someone who's a smaller investor, and I don't mean retail, retail, but let's say someone who's a slightly active investor, how can they use these signals to form a judgement on what to do or not? Or is that sort of like a go, no-go area, which one can conclude or infer from looking at publicly available data?
Amit Tandon: Look, there are a couple of things. We do put up some of our voting recommendations on social media. I'd like it to be exhaustive, but what we do say is that whether you should vote for or against, and if those are read in conjunction with our voting guidelines, the retail investors, or as you say, maybe the family offices and someone who are a little bit more engaged in the companies they've invested in can follow.
So that's the grant work which we do for our paying clients, but nonetheless, there's a kind of taking you halfway there. What we've also done is we've worked with the depositories. And what we are doing is from, I think by the end of the month, we will have our base recommendations, voted for or against, available for retail investors.
You know, when they're going to vote they can click on the link to figure out what is going on. But the broader point which we have and something which we've said in our voting guidelines that we repeat each year, you know, it's for the votes to explain themselves. They just can't assume that because we've done it in the past, we have a right to do it now.
You know, shareholders have changed. The market expectations have changed. You've got a set of shareholders who may not be aware of the context.
So therefore, it's always good if the board makes that extra effort to explain why they're doing what they're doing. You have to remember at the end of the day, there is an alignment of interest between, you know, the promoters who might own 50 percent of the equity and the other shareholders who own the balance 50. And investors recognise that what is good for one has to be by and large good for the other.
But you need to explain it a little bit more clearly.
Govindraj Ethiraj: Right. And last question. So given things as they are, what are the kind of regulatory interventions or shifts that you feel could help enhance the overall levels of transparency?
And let's say pressure to some extent on companies to be more transparent and articulate when they argue their cases for all these points that you typically vote for or against.
Amit Tandon: There was one thing the regulators have done. They've kind of got, you know, two categories. I'm kind of simplifying it to categories of resolutions, which are ordinary and special.
Ordinary needs a simple majority to get approval of those present and working. Special needs 75 percent. So what the regulators have played around is they've said that moving resolutions from ordinary to special.
The other thing which they did was they introduced from the New Companies Act, majority of minority, which means that, look, if you're an interested party, you don't get to vote on that resolution. The third, of course, is you've got e-voting so that each vote is counted. So therefore, the regulators have moved things forward.
But nonetheless, if we find that 94 percent, 95 percent of the institutional vote is for, 100 percent of the promoter vote is for, 99 percent of the other shareholders vote is for, you find that if you kind of exclude the abstains, about 98, 99 percent of the votes are for. So what we've said is that, look, in case there is dissent and we've just looked at a number of, you look at the total dissent is more than 10 percent, it will be good to have a review mechanism, a shareholder dissent review mechanism where the company kind of then explains that, look, we hear what you're saying, but we've still gone ahead. The resolution got approved because of the construct of ownership.
But what we want you to do is explain yourself a little bit better in terms of will you make that change next year or why is it that you still believe what you've done is the right thing to do. So it's kind of just a little bit of disclosures rather than make a broad brush change to that. There is, of course, one other item where we've said that, look, maybe for promoter compensation, we need to move to a majority of minority because when we've looked at the data for about three years, four years now, 25 percent of them would have been defeated if the promoters were not voting on that resolution.
So we've said maybe you move that to a majority of minority and you introduce a shareholder dissent review mechanism to kind of feel that shareholders have a greater say in what the voting and the outcomes are.
Govindraj Ethiraj: Amit, it's been a pleasure. Thank you so much for joining me.
Amit Tandon: Thanks a lot.
