Conclusion: Stagflation looks poised to accelerate in India alongside a reduction in the central bank’s credibility.
Position: We remain bearish on Indian equities and bearish on Indian rupee-denominated debt for the intermediate-term TREND. Bearish on the Indian rupee (INR) for the intermediate-term TREND (vs. SGD, CNY, GBP, EUR, and CAD).
Through a series of what we described along the way as “glaring monetary and fiscal policy missteps”, India has managed to accomplish what few countries are able to do in having us be outright bearish on all three of their major liquid asset classes. The laundry list of bad policy actions in India is both long and hard to defend to anyone who possesses a Global Macro process to interpret them in their entirety:
- Early 2010: Indian Prime Minister Manmohan Singh welcomes more potentially-destabilizing and inflationary capital inflows by increasing the overseas investment cap on Indian government and corporate bonds by +$5B and +$30B each;
- June 2010: Indian Government allows fuel prices to be market-determined for the first time since December 2003. At the time, India’s basket of crude oil was $74.3/bbl.;
- November 2010: The Reserve Bank of India (RBI) stepped up its daily lending to Indian banks, relaxed a ruling that requires them to invest in government bonds, and began holding additional money-market auctions and open-market purchases of government bonds (QE) to help increase liquidity in its “cash-strapped” banking system;
- November 2010: RBI goes on hold citing “transitory commodity inflation” and their overly-benign March 2011 WPI forecast of +5% YoY as a reason to delay further tightening (for reference, actual March 2011 WPI came in at +9% YoY and the central bank’s March 2011 WPI forecast was upwardly revised FOUR times to +8% YoY in the four months leading up the actual report);
- February 2011: Finance Minister Pranab Mukherjee unveils the FY12 budget, which is full of sales tax hikes and symbolic, but not meaningful, income tax deductions. In addition, the revenue projections are based on +9.25% YoY GDP growth, which is higher than the government’s official estimate of +8.6% YoY and the central bank’s estimate of +8%, which was revised down today from +8.6% YoY.
- March 2011: Indian Government increases fuel prices to reflect a basket of crude oil at $110.70/bbl.
The net result of these policy blunders is that inflation is up and to the right in India; for this reason, we remain bearish on rupee-denominated debt. Absent a very significant pullback in commodity prices (which would more than likely manifest itself across all risk assets due to the overwhelming US Dollar Correlation Risk Bernanke has imposed on global markets), we are likely to continue to see inflation in India make higher-highs over the intermediate-term TREND. After many months of resisting and trying to extend and pretend on inflation risk, the Reserve Bank of India finally capitulated, today admitting that inflation is anything but “transitory” in India:
“The inflation rate will remain close to the March 2011 level over the first half of 2011-12, before declining… These projections factor in an upward revision of petrol and diesel prices.”
-RBI Governor Duvuuri Subbarao
This defeated commentary was provided alongside India’s first +50bps hike of the current tightening cycle, after eight +25bps hikes since March of 2010. As we’ve called out in our recent work, their actions leading up to today’s accelerated rate hike have put them at risk of losing credibility; now that credibility is officially being eroded alongside the market cap of the SENSEX, which plunged (-2.4%) today and closed down (-9.6%) YTD as the worst performing major equity market globally. At one point, the BSE SENSEX 30 Index was down (-16.9%) from its cycle peak on November 5th to its February 2nd bottom. Indian equities remain broken from a TRADE & TREND perspective and we will look to re-short them on strength in the Virtual Portfolio.
Interestingly, the RBI did provide an update to their economic assessment with this latest rate hike and prepared remarks – an update that matches bearish Hedgeye estimates (at least directionally, that is). Accordingly, they affirmed our call that Growth Slows as Inflation Accelerates by rhetorically committing to tackling inflation and its associated expectations – even at the expense of growth:
“Current elevated rates of inflation pose significant risks to future growth. Bringing them down, therefore, even at the cost of some growth in the short-run, should take precedence.”
-RBI Governor Duvuuri Subbarao
As inflation ramps up in the coming months, we expect India’s consumption growth to deflate, its GDP Deflator to inflate, and the central bank to continue hiking interest rates in an aggressive manner, which would likely constrain credit expansion and industrial production growth in coming quarters as well. As such, we see an air pocket developing below India’s Manufacturing PMI, which is currently at a five-month high of 58.
Shifting gears a bit, as point of clarification, we typically don’t want to be short currencies that are aggressively tightening monetary policy, as India looks poised to do. We do, however, feel comfortable taking such risk given our out-of-consensus calls for: a) India to miss its fiscal deficit reduction target (likely by a wide margin); and b) Bernanke’s Indefinitely Dovish monetary policy to continue fueling cross-asset correlation risk, which would likely result in a broad-based de-risking of institutional portfolios in the event of a US Currency Crash. Historically, the Indian rupee has traded in lockstep with Indian equities, suggesting that the general appetite for risk has been the dominant factor driving the currency. The backdrop of slowing growth, accelerating inflation, and aggressive tightening of monetary policy do not support any incremental tolerance of risk towards Indian assets.
Make no mistake; The Trifecta is not something investors with exposure to India should take lightly given, given just how quickly international capital can drain from Indian assets. If we’ve learned anything from 2008, it’s that the “flows” works both ways, and when they turn, they can turn hard and fast. Keep in mind that the 2008-09 crash in Indian equity markets was aided by a (-$12.9B) outflow of international capital in 2008. Last year, Indian equities saw a +$29.4B inflow, which was followed by a +$919M inflow YTD. Them be a lot of redemptions potentially waiting to happen…
All told, we’ll be looking to express these ideas in our Virtual Portfolio in the coming weeks and recommend you do the same in yours.
Appendix: Within my coverage areas (Asia, Latin America, and Munis), Indian equities, rupee-denominated debt, and the Indian rupee itself remain three of my least favorite investment opportunities. Our Global Macro process allowed us to turn appropriately bearish on them in early November, and the same process continues to flag further downside in all three areas. With a major sell-side institution coming out today as incrementally bearish on Indian growth and incrementally bullish on Indian inflation, the question becomes, “Is this all priced in?” Our answer is a resounding “NO”; the street is not yet Bearish Enough on India. The reports below will detail why (email us for copies):
India’s Two Big Problems (11/9/10): We expect inflation to continue to be a major headwind for the Indian economy and we see further tightening on the horizon. In addition, the potential for destabilizing withdrawals of foreign investment has breached its 2007 highs, which suggest Indian equities could experience major declines should global markets come under pressure.
India’s Two Factor Squeeze (1/6/11): We remain cautious on Indian equities as growth looks to slow due to a cash shortage and additional monetary policy tightening on the horizon. Further, we see inflation as a much larger headwind in India than we feel is currently priced into its equity market.
Top Emerging Market Short Ideas: Indian Equities (1/26/11): If you agree with our October call that EM assets will come under pressure and remain that way over the intermediate-term TREND, then you’re likely looking for short ideas. If so, we think Indian equities are among the top short ideas in this space, supported by the fundamental backdrop of slowing growth, accelerating inflation and interconnected risk compounding.
Falling Like a BRICk: Is India the Next Egypt?: (2/3/11): 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.
The “Flows” Are Reversing For India Equities (2/15/11): Slowing growth and accelerating inflation indeed have interconnected risk compounding in India as the “flows” are currently working against its equity market(s).
India: Missing Where It Matters Most (2/28/11): Finance Minister Mukherjee’s budget failed to adequately address the #1 issue facing the Indian economy – inflation. As a result, our bearish stance on Indian equities continues unabated. Further, we don’t see India meeting its FY12 deficit reduction target as a likely outcome.