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.

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