Conclusion: Our call that Growth Slows as Inflation Accelerates continues to play out in spades and we see more Stagflation in India’s intermediate-term future.
Position: Short Indian Equities (INP)
By now, it’s pretty clear that the global economy is cooling. Be it a “transitory soft patch" or the turning of the global economic cycle, the net result is the same – earnings estimates need to come down. How deep in magnitude and far out in duration negative revisions must take place is a topic that will be ferociously debated, largely due to the levered long nature of this current “bull” market.
Shifting to India specifically, our call that Growth Slows as Inflation Accelerates continues to play out in spades and we see more Stagflation in India’s intermediate-term future. Currently, all three of India’s major liquid asset classes confirm this thesis:
Equity Market: India’s SENSEX Index is down -9.2% YTD and remains broken from a TRADE & TREND perspective in our quant models:
Currency Market: India’s Rupee is flat YTD vs. the USD (astonishing for a country that’s raised rates three times YTD in the face of the Fed’s Indefinitely Dovish policy) and it is also down -1.4% vs. the USD since peaking on April 8th:
Bond Market: While still up +36bps YTD on upwardly-revised inflation and rate hike expectations, India’s 10Y sovereign bond yields have plummeted -18bps since peaking on May 30th. India’s yield curve (10Y-2Y spread), which had been falling YTD mostly due to the advance in short-term rates, is now at 2bps wide from 14bps prior to the recent move in long-term rates. From a corporate perspective, India’s 10Y AAA-rated credit spreads have widened +32bps since May 30th:
Alongside India’s Manufacturing PMI falling in May to 57.5 from a “toppy” 58 reading, we think these markets are leading indicators for further slowing of the Indian economy. Recently, C. Rangarajan, Chairman of the Prime Minister’s Economic Advisory Council, cut his estimate for India’s FY12 GDP by -50bps to +8.5% YoY. We think that’s still too high.
Additionally, accelerating inflation remains a risk over at least the next 3-6 months as the recent +8.5% increase in gasoline prices, a potential diesel price hike, and an expected +20-30% increase in food prices in 2H (according to India’s Commission for Agricultural Costs and Prices) all combine to give India’s WPI enough momentum to “comp the comps” in the coming months.
From a policy perspective, we continue to affirm our once-contrarian view that India is very likely to miss its deficit reduction target in FY12 (4.6% of GDP) due to lower-than-expected tax receipts and flat-out ridiculous assumptions baked into the projections (+9.25% YoY GDP growth; a -38% reduction in energy subsidies).
Net-net, all three of the big Macro drivers (GROWTH, INFLATION, and POLICY) are going the wrong way for India. As such, we continue to see alpha on the short side of India’s equity market, bond market (particularly corporate), and her currency (INR). At a bare minimum, long-term investors should continue to remain underweight of Indian assets for the intermediate-term TREND.