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Conclusion: Inflation in India continues to come in hot, increasing the likelihood of Egyptian-style social unrest in the world’s second-largest country (population). Moreover, slowing growth, accelerating inflation, tighter monetary policy, and an erosion of financial liquidity continues to make Indian equities one of our top short ideas.

Position: Bearish on Indian Equities and Indian Debt (officially since November 9th).

Pulling up a chart of Indian equities, we can’t help but make the inference alluded to in the title of this note. The SENSEX, down (-10%) YTD including today’s +2% gain, is the world’s worst performing equity market outside of Egypt. Putting the perpetually bullish “BRIC” storytelling aside, India is home to many of the same problems facing Egyptian citizens and politicians:

A large percentage of its population in poverty: Roughly 71% of India’s citizens live on less than $2/day at PPP and ~25% of its population lives below the government-established poverty line, which, apparently, is a lot lower than $2/day.

Eroding public accountability and trust in government: The recent arrest and pending trial of former telecommunications minister Andimuthu Raja highlights the gridlock occurring in Indian politics in the wake of corruption charges lobbed against many present and former members of Prime Minister Monmohan Singh’s ruling Congress Party.

The arrest, perhaps three years too late, makes Raja the first former minister of India to be arrested while his party was still in power. While that may seem like a bullish data point as far as accountability goes, Prime Minster Sign continues to refuse a joint probe into the auction in question. The opposition to Singh’s preference for opacity, led by Arun Jaitley’s Bharatiya Janata Party, has stalled parliament and disrupted the most recent session (Dec) so much so that it was the least productive in 25 years.

With food inflation running in the mid-to-high teens, an unproductive government is not exactly what India needs at this moment. The BJP is already staging demonstrations across the country in protest of these rising prices. Facing elections in five States over the next five months, Singh’s coalition government is predicted to lose the ~40-42 seats by a recent poll published by the India Today news magazine.

A major inflation problem: India’s benchmark Wholesale Price Index continues to hover roughly +400bps higher than the central bank’s target, accelerating in December to +8.4% YoY. Food, fuel and primary articles inflation continue to be driving forces, each accelerating last week to +17.1% YoY, +11.6% YoY, and +18.44% YoY respectively.

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Could India Become the Next Egypt?

Aside from sheer size, the only thing separating India from many of the MENA economies is its incredibly robust growth profile – on track to grow almost +9% YoY in 2010. Unfortunately, both we and the SENSEX’s performance (or lack thereof) believe that accelerating growth is in the rear view. In a report we published on January 26th titled: “Top Emerging Market Short Ideas: Indian Equities”, we wrote:

“While we’re not calling for a significant draw-down in Indian growth, we do think the confluence of tough comps, accelerating inflation, tighter monetary policy and a general erosion of financial liquidity could cause Indian GDP growth to slow sequentially by a full (-100bps) in 1H11.”

The main takeaway here is that India, which some believe is immune to the contagious effects of the Jasmine Revolution because of its burgeoning economy, could become much, much less immune as growth slows and inflation accelerates throughout the year.

While we’d be reckless to forecast a social upheaval at this point, India does screen “positively” on our metrics for identifying potential problem countries like Egypt and Tunisia. In fact, it’s among the poorest on two of our preferred metrics:

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Using this data, we created an index to identify which countries would be most likely to experience some sort of uprising or social unrest as a result of accelerating inflation – i.e. which country’s citizens will be most disgruntled with rising prices of food and fuel, understanding full well that people don’t risk their lives rioting because of “core” inflation.

The chart below sums the rankings (1-17) for each of the countries in the chart above on “Median Age” and “Percentage of Population Living Below the Poverty Line”. As you can see, India screens “favorably” here, receiving the same score as Egypt:

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Add in a government that is losing both credibility and support by the day and the potential for growth to experience a measured slowdown, and it’s clear to see that India has every possibility to become the next Egypt in the event we continue to see the parabolic moves in commodity prices. Currently the US dollar is broken on all three of our core investment durations, so further weakness there only perpetuates the likelihood of this outcome.

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Perhaps that’s why India is broken TRADE, TREND, and TAIL as well. The performance of Indian assets now hinges squarely on The Ber-nank’s Burning Bone. Keep your eye on the US dollar as it relates to India and other emerging markets. Indian equities remain one of our top short ideas not currently in the Virtual Portfolio.

Darius Dale


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