Tuesday, July 24, 2012


GOVERNMENT INERTIA “The policy of being too cautious is the greatest risk of all.” (Jawaharlal Nehru) When the UPA II was installed in to power at New Delhi, there was opinion that the ‘dream team’ of Dr Manmohan Singh, Mr P C Chidambaram and some key bureaucrats like Montek Singh was back and we could expect to revisit the 1991 reforms all over again. Euphoria was so much that on the day the election results came in, the markets opened gap up with a gain of over five hundred points. Since then, this government has been a series of disappointments. I do not want to debate here whether this dream team deserves any credit at all for what happened in 1991. But, suffice to say that this time around, they have left the markets and the investors high and dry. Initially, we all were led to believe by the government that the Euro crises were a western disease and that we would not catch any side effects. Then we were consoling ourselves that whilst our growth rate is slipping, we will still grow faster than other economies. The government officials were busy trying to persuade us that in the world of the blind, “one-eyed” is king. Inflation has been another area where the government policies have not been able to make any impact, except in perhaps a negative way. Populist moves that give away something free to others, generally tend to add to money supply, without doing much. The government policies (or lack of any impetus or fresh initiatives) have left the markets at the mercy of market forces of demand and supply. Central bank stance and the government stance seem to be at apparent conflict with each other. Which of them is right, time will tell. Our markets are witnessing a strange divide. There is a huge demand for high quality stocks (FMCG, Pharma etc) that have become very expensive. It is very unlikely that anyone will make serious money buying the stocks at present levels. At the same time, the high risk stocks have cooled off and will perhaps drive the next round of the market rally when it happens. By no stretch of imagination can this market be labelled as a bear market. The broad markets are trading at sixteen times earnings and it is possible that the earnings growth in the coming financial year may be in single digits. Stocks from the PSU universe continue to behave like yo-yos based on what one feels about government policy, each day. For example, when the government policy was interpreted as freeing the oil sector, the oil marketing companies looked good. However, when it was realised that the government is shy of addressing the subsidy issue, the same stocks looked not so attractive. Judicial activism also is at odds with market forces. We saw what happened to the stock of Indraprastha Gas which stands accused of making too much money. Government policies are in a kind of limbo at this stage. One is not clear whether the exit of Pranab Mukherjee from the Finance Ministry and the Prime Minister assuming the role will result in any improvement in the situation. The sharp deterioration in the rupee dollar exchange rate has led to tremendous losses for foreign investors who have already put money in to India. Given our inflation, the rupee can only weaken further. To nullify this, we have to attract FDI and / or FII money in a big way. That can come only if the government policies are stable and not capricious. The threat of retrospective taxation has shaken the faith of people across the globe. Perhaps this one factor (GAAR) has been the single largest contributor to the sad state our stock and currency markets. The real issue is that we have not had the government address anything with reference to economy or markets over the last three years. The expectations have gone so low that anything they do will be viewed as positive by our markets. In a sense, our markets presently seem to have priced in a view that this government will not do anything positive to boost the economy. So, fundamentals apart, the government policy changes, should hopefully bring cheer to the markets. I am not talking about more bail out or dole packages (like NREGA etc) but something positive like hiking diesel / kerosene prices, reducing any other subsidy or lowering interest rates or giving incentives to promote new industries etc. At this juncture, when it is clear to everyone, including the politicians, that India cannot be islanded from global troubles, we need positive or affirmative action from the government. This government has just two years left to complete its full term. With each passing day, the possibility of voluntary action to improve the economy seems to be reducing. There is only reaction to events. Hence, my take is that there is safety in fixed income. I don’t mind sacrificing the upside in equities (from here, there is not much upside left, though valuations are not very stretched except for the good quality stocks) for peace of mind. And inflation refuses to budge much lower, thus delaying the fall in interest rates.

Tuesday, July 10, 2012


(This appeared in the Deccan Chronicle of 8th July, with a misleading headline) The battle against inflation seems to be a lost one for us. Nearly four years and there is no sign of abatement yet. Clearly, even in a flagging economy, the rate of inflation is a very clear indicator that there is a supply crunch. This high inflation also depreciates our currency quickly and compounds the problem as the import content in inflation (petrol, diesel, transportation etc). Following classical economics, the RBI wants to follow a tight money policy and not lower interest rates. At the same time, the ruling party in the government of India want to show that there are no issues and wants to give away freebies. This is a classic conflict that is playing itself around the world. In all this, the big winner has been inflation and no one else. Apart from impacting us on our spending habits, inflation and the consequential weakening of the rupee do have a bearing on some of the listed companies. Firstly, I have to take a view as to whether the rupee will weaken or strengthen from here. Logically, a country with a rate of inflation higher than the US and with continuing trade deficit will look at a consistently and continually falling currency. There can be relief to the currency from flows in to the country through migrant remittances, loans, FDI and FII investments. Whilst we had all these in the past, it has not stopped the rupee from falling. It merely delayed the process. In essence our need for dollars seems to be higher than the available dollars. It is logical to assume that companies that are net foreign exchange earners will gain. This is true, if they always earned in dollars and are able to hold their dollar prices for the goods or services that they supply. What happens in reality is that they get some immediate benefits and after that, competition results in a lower dollar price. Thus, over a reasonable time frame, the falling currency does not help anyone. There are those who say that a falling rupee is good for exporters and that a rising rupee hurts exporters. This simply is a reflection on the inefficiency of our exporters. If a rising domestic currency were to hurt, would Japan (the Jap Yen moved from over 300 Yen to the dollar to the present level of 80 Yen to the dollar over the last four or so decades) have continued to increase its exports? If we take the gem and jewellery industry, the value addition is very thin. Imports are in foreign currency. Thus, changes in exchange rates do not mean much except over the very very short term. Similarly, in the IT industry, there will be competitive pressures that will keep dollar prices falling as the rupee keeps weakening. Thus, the worst impact is on the Indian consumer due to our dependency on oil imports. Similarly, our import of unproductive but fear led gold contributes to the single largest reason for why our rupee is falling. If private gold imports were halted, we can address a major issue. Our passion for gold becomes a kind of self fulfilling proposition. The more the gold we import, the higher the pressure on the rupee and the more expensive gold becomes for the Indian. Out of our dollar shortage of nearly three hundred billion dollars, gold alone contributes to over one hundred billion dollars! And gold is intrinsically an unproductive asset. We may see some industries like natural resources lock in to a bit more money as domestic prices do tend to track global prices. Consumer price inflation also gets adversely impacted when the rupee is weak. Thus the FMCG companies will make a bit more money. The biggest fear all of us should have is about the monster called “Stagflation”. This happens when supply does not increase, but prices keep going up. Our economy is particularly vulnerable as demand continues to be high, driven by rising wages and the small base we have started from. In these times, it is tough to find investments that will grow faster than the rate of inflation. All consumer co stocks are expensive and more upside based on valuations are not on. At best, one can keep money in liquid funds or in bonds or debentures. The return can vary from seven to ten percent. One possibility is to hope for a cut in interest rates. This can happen either due to policy action or tapering off of demand or a combination of both. As this happens, investment in to income funds or debt instruments can also give some capital appreciation. This is not a bad option considering the valuations in the equity markets which make the risk reward equation unfavourable for equities right now. Returns from fixed income seem to be high enough to stop one from switching more money in to equities.