Iain Macleod (1913-1970) earned a respectable living as a bridge professional between 1935 and 1950 before abandoning the card-table for a punt at politics. He died in office as chancellor of the exchequer (the British equivalent of finance minister). Macleod is best remembered now for a 1965 speech he made while sitting in opposition. He said: “We now have the worst of both worlds — not just inflation on the one side or stagnation on the other, but both together. We have a sort of stagflation situation.”
The “S” word, which he coined, is being mouthed with increasing frequency by India-watchers. It describes the current conditions pretty well. Inflation has been above the Reserve Bank of India’s (RBI’s) comfort zone for the past two years. It is unlikely to fall any time soon, given that the consumer price index was up 10.4 per cent in April 2012.
Meanwhile, growth has fallen for over a year. Corporate earnings records indicate that deceleration started in Oct-Dec 2010 (Q3, 2010-11). Macro-economic data suggest that the GDP slowdown started even earlier, in July-Sep 2010 (Q2, 2010-11), when quarterly GDP growth dropped to 8.3 per cent (from around nine per cent in April-June 2010).
Things clearly got worse in the second half of 2011-12, when growth dropped below seven per cent. For what it’s worth, the index of industrial production, or IIP, (-3.1 per cent in March 2012) suggests that there may be contraction in certain manufacturing sectors, and there aren’t any signs of bottoming out yet. The IIP data are frequently dubious, but this gels with corporate results and other signals.
So, we have falling growth and rising prices. For much of 2011, that was reflected in falling equity values. There was a brief rally in early 2012 as portfolio investors pumped in large sums. Once foreign institutional investors (FIIs) soured on the “risk-on” India story, equity prices started to realign downwards.
||Current (May 18)
||Value 14 days ago
|Index divident yield
|Index book value
|USD-INR (RBI ref rate)
|FII net buys/sales (May 4-18)*
-781 (Apr20-May 3)
|DII net buys/ sales (May 4-18)*
-563 (Apr 20-May 3)
|* Rs crore
Stagflation is often caused by external supply shocks. That is certainly a serious factor here. Energy prices shot up during the “Arab Spring” that began in the winter of 2010. They have stayed up because the Spring hasn’t yet run its course. That, in turn, has driven up other prices. An unwillingness to take corrective policy action has also led to growth being choked up.
The global economy may take a long time to move towards recovery — the projections suggest very low growth or contraction in the next year. The news from Europe has got worse. Greece may exit the euro currency union with some disruptive effect. Larger, sounder economies like Spain and Italy are in serious trouble. France isn’t in a mood for austerity. Recent provincial elections in Germany have made Merkel’s position a little shaky.
One apparent effect of the uncertainty is fence-sitting by FIIs. They’ve been net sellers in India in the past four weeks, but they’ve also scaled down operations considerably. Most probably, they’re going to wait until things clarify in the euro zone before they make major decisions about Indian allocations again.
The low-volume action by FIIs has reduced the pressure on the rupee somewhat. But the huge trade gap is also making itself felt and the currency has hit record lows. The long USD-INR position continues to look attractive, and the rupee could travel down a long way from here before it rebounds. The RBI will occasionally intervene, but it lacks the firepower to generate a trend reversal. At some stage, it may also be worth looking at a short EUR-INR trade — because the rupee could appreciate suddenly against the euro if the entire continent goes into another round of crisis.
The full-year corporate results suggest that most businesses are struggling to cope with the environment. A recent analysis in this newspaper (“Fab five sectors salvage India Inc’s bottom line,” May 15) shows that there were just five sectors that registered significant profit growth in the fourth quarter of 2011-12.
These include classic defensive havens like fast-moving consumer goods and pharma, as well as IT, banking — and, of all things, cement. IT advisories about FY 2012-13 have been distinctly cautious. Banking and cement may, for different reasons, find it difficult to maintain momentum in a stagflationary environment.
Meanwhile, cyclicals like automobiles, metals and capital goods are seriously suffering. Infrastructure, where activity could provide a pump-priming effect, is stuck in a morass. The power sector is suffering mounting losses owing to energy bottlenecks. Telecom is enmeshed in legal tangles and unreal auction pricing estimates. Other segments are unable to acquire either land, or environmental clearances. The cyclicals could bottom out naturally over the next two or three quarters. Infrastructure will, however, require policy action to enable a revival.
In terms of valuations, the consensus estimates for the Nifty now suggest earnings growth in the range of 13-14 per cent for 2012-13. That’s a forward price-equity ratio of roughly 14, and a current PE ratio of 17 (at present index levels). Therefore, the index is not massively over-valued, though it is rich. There is some margin of safety for an investor with a two-year perspective.
Technically, there’s quite a lot of support at 4750 and that may hold under normal circumstances. If 4750 breaks, the next support would be in region of 4525-4575. If that breaks as well, the stock market would be headed for a multi-year low.
It would require a collapse in sentiment to drive the index down well below fair-value. There’s a sufficiency of potential news-based events that could trigger a panic. A George Soros-Karl Popper fan would have faith in the probability of such a collapse. The Popperian concept of reflexivity suggests that, once a market trend is established, it usually runs well beyond rational limits.