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Posts Tagged ‘CPI’

Asia’s biggest economy & the world’s second largest economy is slowing, the Federal Reserve is about to kick off an interest rate tightening cycle, and China has just devalued its currency. Is this the repeat of Asian Financial crisis we saw in 1997? There are certainly parallels, but important differences as well. This time around, Asian economies have stronger current account balances, fiscal positions and foreign exchange reserves that provide a thicker buffer against turbulence. In addition, the exchange pegs that existed at that point have seen significant changes as well.

China’s Yuan devaluation comes on top of a steep slowdown in the world’s second-biggest and Asia’s biggest economy (Japan was No. 1 back in 1994) and a commodities slump that is hurting nations from Brazil to Australia, Malaysia and South Africa. Chinese companies now threaten to displace exports from Asian and emerging market competitors just as the U.S. Federal Reserve prepares to raise interest rates for the first time since the global financial crisis.

Analysts have also questioned China’s growth outlook although it posted economic growth of 7% year on-year in the second quarter, unchanged from the first quarter. They point out that Chinese growth cannot be sustained in the second half of the year given the exports decline and the drop in financial services’ contribution to the economy following the Chinese equity rout. They said a lot more may be needed to achieve this year’s target growth rate of 7% for the economy, given the weaker-than-expected macroeconomic data in recent weeks. To-date, Beijing has cut interest rates four times since November and also reduced the amount of money that banks need to keep with the central bank. Also, large infrastructure projects continue to have funding. However, the good news is that falling real estate prices in China, which were seen as a very big threat, have started to stabilize.

Let’s take a look at why is this happening? After the sub-prime crisis in the US and the steep fall in markets following the Lehman Brothers bust, the world has tried to solve the problem by throwing more and more money at the problem – money printed and lent out at near zero interest rates almost all over the developed world.

The US, after seven years of grappling with the problem, is still making only intermittent noises about raising interest rates; if the markets continue to crash and the global economy slows down, it may yet chicken out; Europe is keeping near zero rates in the hope growth will revive even as Greece is trashing about for survival; Japan kept the money-printing presses working overtime for more than a decade, but has, under Shinzo Abe, gone back to the same trick of monetary expansion.

The Chinese are unable to grapple with the new challenges that come with becoming the world’s second largest economy and key driver of demand. Two issues are paramount: one, there is huge financial repression, where Chinese savers are paid low returns and the cheap money raised from them has been invested uneconomically in unwanted infrastructure; and two, while financial repression helped fund investment-led growth over the last three decades, today it is constricting consumption – which is what China needs to boost internal growth.

India could use the opportunity provided by China’s problems to get its own growth engines revving. The tumult in China’s stock markets has turned into a blessing for Indian shareholders. Investors who poured into India in 2014 pulled back this year over concerns about taxes and the slow pace of reforms, preferring markets such as China, Taiwan and South Korea..

Now, fears about Chinese stock market volatility and Beijing’s interventions are overriding those concerns and driving them back to India. In this way India can have a much bigger pie of global capital which it can use to fund infrastructure requirements.

We find India a good alternative, given its improved macro data.

On the inflation front, a fall in both Consumer Price Index(CPI) and Wholesale Price Index (WPI) continued. CPI based inflation in July decreased to 3.78% from 5.4% in June 2015 due to a higher base last year. WPI fell for 9th consecutive month to -4.05% from -2.4% in the previous month. India is gaining from cheaper commodity prices. Cheap global crude and commodity prices mean that the imported component of inflation will also be lower. In fact, its impact is clearly visible in the wholesale price index, which has been showing negative growth for nine consecutive months now, mainly due to high deflation in minerals and mineral oil. India imported $139 billion worth crude and petroleum products in the 2015 fiscal, and as a rough rule of thumb, every $1 drop in crude prices results in a $1 billion drop in the country’s oil import bill. This will be good for reduction in India’s Current Account Deficit. India also imports $3 billion of copper and copper products. Also, lower input costs translate into higher profit margins for many Indian corporates. This will be a major respite for them. Due to depressed domestic demand, they had been struggling with their pricing power over the past few years, and were not able to pass on the increased cost.

With the government of India focusing on “Make in India,” this may be the time to provide impetus to manufacturing and even invite Chinese companies to set up a manufacturing base in India. However, this may require fast-tracking several pending economic reforms and easing the norms for doing business in India.

The Indian rupee has also been relatively stable over the last couple of years, vis a vis other emerging market currencies. This relative stability of the Indian currency, adds comfort to investors looking to invest in India.

Last but not the least, whilst most parts of the developed world are currently sitting on record low interest rates, India is one of the few countries which can potentially see interest rates getting cut, making it attractive for both companies to begin their investment cycle, as well as improve margins for corporate India going forward.

All in all, China’s pain could be India’s gain, but it won’t come easy. After all, there are no easy roads to success, doors only open to a combination of hard work and the constant desire to get better.

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Indian Equity markets once again touched all time highs by crossing the 28500 level on the BSE SENSEX due to various reasons like structural reforms made by strong government, weak commodity and oil prices, inflation easing further, improvement in macros and continued foreign flows on the back of strong  liquidity conditions overseas

Equities:  The CNX Nifty and CNX Midcap increased by approx. 6% in the last one month. The local market sentiment has remained buoyant through the last few quarters as the market anticipates a strong domestic recovery and lower interest rates in an improving policy environment. Various macro factors like GDP growth, Current Account Deficit (CAD), Fiscal deficit (FD), IIP, WPI and CPI are showing an encouraging trend in FY 2014-15, compared to last year FY 2013.

Featured imageSource:  Citi Research, HDFC MF, Colored rows refer to yearly data; other represent quarterly data

Corporate margins are currently at cyclical lows, and though earnings are still to significantly pick up and may take a few more quarters, better managed companies are starting to show some traction. As corporate margins normalize from depressed levels and as interest rates move lower, current P/Es that look expensive could start to look much more justifiable.

However, it is critical to have a long term horizon for investors buying into equities as always, as there could be volatility in the short term, especially with a consensus positive view on India. A consensus positive view tends to be a good contrarian indicator very often, so having a long term view and holding some cash to buy on corrections could be a good idea.

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While the U.S. continues to normalize its monetary policies, the same does not apply elsewhere. To overcome weakness in Europe, China and Japan, the respective central banks are taking steps towards more monetary easing to stimulate growth in their economies.

Emerging Markets like India and China have adopted a more flexible exchange rate system, increased Foreign Exchange reserves and managed their external debt in an efficient way thus far.

Featured imageSource: MSCI, Credit Suisse, I/B/E/S, FactSet, J.P. Morgan Economics, J.P. Morgan Asset Management “Guide to the Markets – Asia.”

Investors should remain disciplined in maintaining a well-diversified portfolio by investing across domestic and international equities. A global economic recovery should favour equities, especially emerging markets like India and China that are likely to benefit from a global recovery.  Both emerging markets and developed markets should benefit as a result.

Over the long term, the INR should continue to depreciate vs. the USD at nearly the rate of inflation differential between India and US (last 30 years CAGR of INR depreciation vs USD is 5.5 %; inflation differential between India and US is 4.8%). Therefore, we continue to recommend building international exposure in the portfolio for the purpose of diversification and act as a hedge against currency risk.

Fixed Income: While the equity market is on a high, there are good investment opportunities that we foresee in the fixed income market. There are various factors that impact inflation and the table below shows that they are moderating:

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Investors should start looking at bonds and bond funds (a combination of short, medium and long term options would be recommended, depending upon investment objectives and risk appetite) as a means of hedging their future reinvestment risks.

Globally the gap between US &Indian interest rates is currently high, yet, a sharper than expected reversal in US interest rates could lead to volatility / challenges for the Indian fixed income markets as well. Foreign portfolio flows into debt have also been at a high for many months now, as can be seen from the graph below, and thus investors need to be cautious about any reversal in fund flows. Thus maintaining a long term view on fixed income investments (18-36 months) wouldalso be crucial.

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CPI inflation eased to a series-low 5.5% in October 2014 from 6.5% in September 2014 in year-on-year (y-o-y) terms.  This primarily reflected a sharp decline in food inflation to 5.8% in October 2014 from 7.6% in September 2014, even as core inflation was unchanged at 5.9%.

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Source: CSLO, ICRA Research

However, RBI may not cut the rates in the upcoming monetary policy in December unless they are very sure of achieving CPI inflation target of 6% by January’2016. In addition, it may want to reward investors with continued positive real returns of between 1%-1.5% p.a. over and above inflation, which should help monies move from physical assets like real estate and gold to fixed income instruments as well.

Gold: Gold may continue to see downward pressure globally, with weak commodity prices, and less fear amongst global investors. The government has removed gold import restrictions in spite of the fact that gold imports went up significantly in the last festive month to $3.75 billion. Hence, allocating only a small portion of your investments into this asset class continues to be a good strategy in our view.

We came across a very interesting table recently showing the returns on CAGR basis and the risk measured by standard deviation over 1, 3 and 5 years holding periods of the BSE SENSEX, 1 year SBI Fixed deposit (FD) and Gold in INR terms for the last 30 years:

Featured imageSource: Bloomberg, HDFC MF

As you can see from the above data that:

FDs vs Gold: Fixed deposit returns are very close to the Gold returns in the last 30 years; however the volatility or risk in gold is much higher compared to the risk in FD. Hence, Gold is not a superior option compared to FDs to invest in from a risk perspective.

Equities vs Gold:  Long term returns on equities are much higher than returns on gold (appreciation in Sensex was 5x of gold*). Volatility of equity returns is high but to a lesser extent (3x over 3 year holding periods and 2x over 5 year holding periods). Equities are therefore a superior asset class compared to gold for long term investments and for those with tolerance to volatility.

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