THOUGHTS

With the markets not doing much and not much of events going on there was not much to add over the last few weeks. Since I wrote a month back the only major event as far as the domestic scenario goes has been the sharper than expected rate cut by the RBI. The global rally has also struggled to move forward given the new found market concern of Spain. Most armchair economist had been pushing the RBI not to cut citing inflation concerns. However the reality is that the only inflation ex of food and fuel left on the manufactured products side i.e. the inflation that can be controlled by RBI’s monetary policy is “NOTHING”. The only demand side inflation left in the domestic economy comes from imported inflation due to global commodity prices. The extremely tight monetary monetary policy started off the right way,however lost its way on the way. Over the last 6-9 months the only thing that the tight policy has done has increased the stress on the economy and corporate balance sheets. The resultant impact of an increase in bank NPA’s has reduced their ability to pass on the policy rate cuts to consumers as their profitability is under pressure due to higher writeoffs and the Capital adequacy is under pressure due to lesser accretion to the reserves. Poor capital market conditions have also reduced the ability of banks to raise equity from the markets. It has been proven now that demand conditions in the domestic economy are very poor and the driver of inflation is just money printing by global central banks.
Thankfully the US Fed is circumspect about printing more money, ECB seems to have done its bit through its LTRO activities and the last bastion of the money printing brigade the Bank of England has now indicated that it will no longer be printing more money. This should now lead to the extreme speculation in commodities coming under control and in my view also reduces the last remaining support for gold prices which should now see a much sharper correction during the remaining part of the year 2012. The only reason that inflation in India is still high is because of the nearly 15% depreciation of the rupee over the last year. Most commodity prices are down by nearly 10-20% during the same time globally.


Concerns on the twin deficits in India have grown over the last few months. The Fiscal deficit projections are looking more and more far fetched with the inability of the government to push fuel prices and uncertain capital market conditions combined with the GAAR confusion is making the disinvestment targets look more uncertain. It is weird that the government has chosen to create so much uncertainty for both FII and FDI investments at the time when the Current Account Deficit is under so much stress. On top of that we have seen statements coming out of the Commerce Secretary over the last week where he has proposed to control the trade deficit by controlling imports. How can they think of such solutions when the economy is so much integrated with the world economy is totally beyond me. That said, I do believe that the CAD this year will be much better as gold imports that contributed nearly  $ 65 billion to the $ 185 billion of deficit in the year 2011-12 should halve this year and reduce the trade deficit by $ 30-35 billion. Exports are suffering due to the high interest rates in the economy. When demand conditions and margins are already under pressure, high interest rates as well as prolonged working capital cycles are impacting export volumes. India is unable to capture the opportunity in exports due to rising wages in China as the incremental advantage is more than going away due to high interest rates that Indian exporters have to bear where the differential today is 8-10%.

Government data continues to confound with the Industrial production data for January being sharply downgraded from 6.8% to 1.1%. Incidentally this data point was used by the RBI for not cutting rates in its last policy meeting. Hopefully things will improve going forward and there will be some learning from the data goof ups that have been happening. I simply do not understand why there is no crosschecking mechanism if the data points are far away from what the economy in general reflects.

A recent study has revealed that the increase in interest rates since the beginning of the rate hike cycle has reduced corporate profits by nearly Rs 80,000 crores. Another study has revealed that  1% increase in interest rates reduces the profits of mid cap companies by nearly 15%. RBI needs to improve liqudity in the economy further so that the policy transmission due to the 50 basis points interest rate cut is proper. If the move is towards a more relaxed monetary policy then the RBI needs to take the borrowing in the repo window to more near zero or in surplus. The other big economic theory that is widely propounded is that high fiscal deficits lead to higher inflation. I believe that it is an extremely fallacious theory. If that was the case then the USA, Japan, Spain etc should have been facing huge inflationary pressures. Inflation is infact induced by the differential in money supply over the nominal GDP growth and given the pace of decleleration in M3 there are no indications that domestic liquidity is leading to higher inflation. 
The results season has started in a mixed manner and till date very few companies have reported. Technology sector results have been mixed, however private banks have reported strong results with good asset qualities. The next two weeks will be important as most large companies will report in this time frame. The results season in the USA seems to be moving better than expected with 80% of companies beating expectations. My hypothesis on the global equity market rally continuing still holds. The US Dollar Index also seems to be shaping up for a further decline which should support the risk rally. The bigger money flow from bonds to equities is imminent and will happen over the next few weeks, months and years. Bonds in developed markets are so crazily overvalued that only a global depression can save them.

Indian markets continue to be cheap on valuations and will form a part of the global equity rally, however as I have reiterated earlier the domestic factors at this point of time do not indicate any reason why India will outperform. Lets hope things will improve going forward and create conditions for India to attract better global fund allocations. This improvement will come only as the economy improves and the confidence on India grows.