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India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
● Every 15-20 years, the perceived importance of monetary
authorities seems to flip: it may do so again. In its 75-year history,
while the RBI has stayed true to its objective of monetary stability,
it has had little impact on inflation on its own (not even post 1999).
In our view, the root cause of inflation is fiscal deficit and how it is
financed: inflation may not fall meaningfully until deficits are high.
● Most inflation forecasts rely on WPI seasonality – this is not just
optimistic, but wrong. Further, about 68% of the WPI is driven
purely by domestic factors, which we expect will continue to rise.
Only if global factors fall 10% (a rare occurrence, coincident with
crises), can inflation fall below 6% by Mar-12E. Moreover, with a
large gap between global and local oil prices, we believe the
impact of lower oil may be delayed.
● Avoid PSU banks: They look over-held, the most exposed to a
potential surge in yields, and are also likely to be hurt by the
stress on government finances. Real estate and four-wheeler
autos typically also underperform when rates are high; twowheeler manufacturers do not. Companies with high interest
expenses (such as Suzlon, United Spirits and DLF) may remain
weak. Conversely, companies with high cash balances (e.g., Coal
India, Sun Pharma) should outperform.
‘Inflation seems to be all important for the Indian economy as well as
the stock markets. There is misplaced hope that inflation will slow in
2H FY11 and growth can resume. We, however, believe we are
headed into a sustained period of slow growth and high inflation.
Fiscal issues driving inflation: RBI may be helpless
In the past 50 years, inflation in India has mostly been high and
volatile – low and stable 5% inflation in 1996-07 seems to have set
market expectations too low. While it is widely believed that the RBI
can control inflation, that is not its mandate, and in 75 years of its
existence, there is little evidence to suggest that RBI can bring down
inflation on its own. In our view, inflation in India is largely a fiscal
phenomenon, and the low inflation in 1996-07 can simply be attributed
to government fiscal discipline and low deficit monetisation.
That period, unfortunately, is now behind us. Fiscal deficits, which are
usually sticky on their way down, are back to the levels last seen in the
1990s, and can reach 6% in FY12E. With government borrowing
threatening to push up yields and crowd out private sector borrowing, by
September, we expect the RBI to start monetising the deficit again.
Worryingly, capital expenditure as a percentage of government spend is at
historical lows: the private sector is to pitch in with the ‘productive’
spending, but is being crowded out, and pushed back by slowing reforms.
By being seen to be targeting inflation and then failing to control it,
authorities can worsen inflation: sustained high inflation expectations
suggest it may already be the case.
Bad inflation arithmetic; imported inflation a ‘wildcard’
Most attempts at predicting inflation resort to using seasonality for
sequential movement in the WPI, and then calculating the YoY rate.
This is not just optimistic (it will always show a drop a few months
down the line), but just wrong: the standard deviation for month-onmonth changes is typically higher than the median assumed to be the
‘seasonal’ number!
About 68% of the WPI, in our view, is influenced primarily by local
factors (WPI Local) and 32% by global factors (WPI Global). We show
that WPI Local has near-zero correlation to inflation globally, and that
WPI Global has a 97% correlation with global commodity prices. If
commodities fell 10% from May-end levels, inflation would be 4.6% by
Mar-12, all else remaining same. Such falls though are rare, and
coincide with crises. In any case, with a gap again opening up
between global and local fuel prices, any large fall in crude may not
affect WPI immediately this time. Further, the WPI Local, driven by
structural factors such as sharply rising wages, is unlikely to fall as
long as the RBI keeps monetising deficits.
Market implications: Avoid PSU banks
In an environment of sustained high rates and high deficits, we would
avoid PSU banks. Not only do they look over-owned and the most
exposed to any sharp surge in yields (as may emerge in 2-3 months),
but historically they have also underperformed the market in periods
of high inflation. With the government’s rising needs, PSU banks are
likely to be called for ‘national duty’ in various creative ways.
Real estate and four-wheeler auto manufacturers also tend to
underperform when rates are high, whereas industry specific drivers
matter more for two-wheelers. While capital goods companies can
also be rate sensitive, they are likely to be more affected by the pace
of reforms taking place.
Consumer staples companies generally outperform when inflation is
high. Companies with high interest costs, such as Suzlon, DLF, United
Spirits, JSW Steel, may also suffer because of the high rates.
Conversely, companies with high cash balances including Coal India
and Sun Pharma should benefit from sustained high rates.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
● Every 15-20 years, the perceived importance of monetary
authorities seems to flip: it may do so again. In its 75-year history,
while the RBI has stayed true to its objective of monetary stability,
it has had little impact on inflation on its own (not even post 1999).
In our view, the root cause of inflation is fiscal deficit and how it is
financed: inflation may not fall meaningfully until deficits are high.
● Most inflation forecasts rely on WPI seasonality – this is not just
optimistic, but wrong. Further, about 68% of the WPI is driven
purely by domestic factors, which we expect will continue to rise.
Only if global factors fall 10% (a rare occurrence, coincident with
crises), can inflation fall below 6% by Mar-12E. Moreover, with a
large gap between global and local oil prices, we believe the
impact of lower oil may be delayed.
● Avoid PSU banks: They look over-held, the most exposed to a
potential surge in yields, and are also likely to be hurt by the
stress on government finances. Real estate and four-wheeler
autos typically also underperform when rates are high; twowheeler manufacturers do not. Companies with high interest
expenses (such as Suzlon, United Spirits and DLF) may remain
weak. Conversely, companies with high cash balances (e.g., Coal
India, Sun Pharma) should outperform.
‘Inflation seems to be all important for the Indian economy as well as
the stock markets. There is misplaced hope that inflation will slow in
2H FY11 and growth can resume. We, however, believe we are
headed into a sustained period of slow growth and high inflation.
Fiscal issues driving inflation: RBI may be helpless
In the past 50 years, inflation in India has mostly been high and
volatile – low and stable 5% inflation in 1996-07 seems to have set
market expectations too low. While it is widely believed that the RBI
can control inflation, that is not its mandate, and in 75 years of its
existence, there is little evidence to suggest that RBI can bring down
inflation on its own. In our view, inflation in India is largely a fiscal
phenomenon, and the low inflation in 1996-07 can simply be attributed
to government fiscal discipline and low deficit monetisation.
That period, unfortunately, is now behind us. Fiscal deficits, which are
usually sticky on their way down, are back to the levels last seen in the
1990s, and can reach 6% in FY12E. With government borrowing
threatening to push up yields and crowd out private sector borrowing, by
September, we expect the RBI to start monetising the deficit again.
Worryingly, capital expenditure as a percentage of government spend is at
historical lows: the private sector is to pitch in with the ‘productive’
spending, but is being crowded out, and pushed back by slowing reforms.
By being seen to be targeting inflation and then failing to control it,
authorities can worsen inflation: sustained high inflation expectations
suggest it may already be the case.
Bad inflation arithmetic; imported inflation a ‘wildcard’
Most attempts at predicting inflation resort to using seasonality for
sequential movement in the WPI, and then calculating the YoY rate.
This is not just optimistic (it will always show a drop a few months
down the line), but just wrong: the standard deviation for month-onmonth changes is typically higher than the median assumed to be the
‘seasonal’ number!
About 68% of the WPI, in our view, is influenced primarily by local
factors (WPI Local) and 32% by global factors (WPI Global). We show
that WPI Local has near-zero correlation to inflation globally, and that
WPI Global has a 97% correlation with global commodity prices. If
commodities fell 10% from May-end levels, inflation would be 4.6% by
Mar-12, all else remaining same. Such falls though are rare, and
coincide with crises. In any case, with a gap again opening up
between global and local fuel prices, any large fall in crude may not
affect WPI immediately this time. Further, the WPI Local, driven by
structural factors such as sharply rising wages, is unlikely to fall as
long as the RBI keeps monetising deficits.
Market implications: Avoid PSU banks
In an environment of sustained high rates and high deficits, we would
avoid PSU banks. Not only do they look over-owned and the most
exposed to any sharp surge in yields (as may emerge in 2-3 months),
but historically they have also underperformed the market in periods
of high inflation. With the government’s rising needs, PSU banks are
likely to be called for ‘national duty’ in various creative ways.
Real estate and four-wheeler auto manufacturers also tend to
underperform when rates are high, whereas industry specific drivers
matter more for two-wheelers. While capital goods companies can
also be rate sensitive, they are likely to be more affected by the pace
of reforms taking place.
Consumer staples companies generally outperform when inflation is
high. Companies with high interest costs, such as Suzlon, DLF, United
Spirits, JSW Steel, may also suffer because of the high rates.
Conversely, companies with high cash balances including Coal India
and Sun Pharma should benefit from sustained high rates.
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