INDIA’S INFLATION PUZZLE

 

For the first time in 30 years, wholesale inflation declined on a year-over-year basis

If you read Keith's note this morning, you know that lately we've come to realize that many people who read our work assume that because our model portfolio is tactical in nature, we are short term traders who operate purely in the moment. This perception is wrong: we execute tactically inside a defined strategic framework. 

Our work on India is a great example of this process: despite the fact that the Sensex is now up over 45% YTD, we are net positive in performance for our trades in Indian equities via IFN for 2009, despite having only taken short positions. Presumably those that accuse us of being short term thinkers consider each of those shorts a unique transaction, but for us it was a a single evolving investment thesis.

Since we opened for business over a year ago, we have had a strategic conviction that equity investors were overly focused on the opportunities for individual companies and industries in India while ignoring major structural issues that stand in the way of real progress on a long term basis. It is because of these macro headwinds that every single time we have taken a position in Indian equities it has been a short.  Some may see these transactions as individual trades, but for us they are all part of a longer term portfolio process. 

Inflation data released yesterday presents an interesting inflection point for our India thesis.  With WPI plunging, one might expect that Indian analysts would be uniformly bullish. After all this it leaves tremendous room for further loosening by the RBI.  Instead consensus among analysts and economists is an expectation that inflation will return rapidly, with a high single digit forecasts for Q1 next year.  This is not in itself a major negative for the Indian economy, but there are key pieces to the puzzle that have yet to be factored in:

  • CPI data is released on a long delay by the department of labor, but as the chart below illustrates, the April data continues to suggest that consumer prices have not declined appreciably despite the collapse in wholesale levels. This does not bode well for consumers when inflation returns.
  • The government plans to divest large positions in state controlled energy companies accompanied by a loosening bias for price caps in order to induce investors to step up. If energy commodity price inflation rears its ugly head in 2010, the dilemma facing investors will be whether rising fuel costs inhibit consumer spending growth or if government price caps destroy margins for refiners and utilities.
  • Even inside the WPI complex, the pricing of many individual components are continuing to increase, and food prices nationally continue to show double digit growth.

We continue to take a pessimistic view of long term opportunities for Indian equities and will opportunistically look for entry points defined by price action to short.  When we do, rest assured, in our minds it will be part of an investment strategy for Asian equities and not just a quick trade.

Andrew Barber

Director

INDIA’S INFLATION PUZZLE - india34


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