September 2015: India in the context of global volatility

We are half way through the current financial year (Apr – Sep), and during this period the Nifty is down 6.4%. Our portfolios did much better than the market and most of the portfolios are positive for the year. Since markets were strong last year, with the Nifty up 26.7%, some correction in the subsequent year is normal. The correction in the current year is led by a combination of international and domestic events.

Led by a severe commodity price correction and concerns over the Chinese economy, there has been a withdrawal of investments from emerging economies. Many large exporters of commodities like Brazil, Russia, Australia, South Africa have seen their respective currencies fall in double digit percentages over the last twelve months with the worst performers down 40%. Compared to that, the fall of 5.9% of the Indian Rupee against the US Dollar seems benign. India is a large importer of commodities like oil, coal and gold. With lower prices of commodities, the total import bill actually comes down and the same goods can be consumed at lower prices. This is clearly good for India. The Indian consumer benefits from lower prices and the government benefits due to lower subsidies. The exact opposite has been the case over the prior 6 years.

Inflation has been the bane for the Indian economy over the last 6 years and has contributed significantly towards holding back the nation from the much talked about ‘true potential’. Over the past 12 months the CPI (Consumer Price Index) has been averaging about 4.4% (Wholesale Price Index has been negative). CPI Inflation has averaged 7.1% per annum over the past 58 years. Since 2008, CPI has been averaging 9.6% pa, whereas in the 1998 – 2007 period, it averaged a reasonable 3.8% pa. The severity of the fall in commodity prices suggests that the back of the inflationary spiral is broken, at least for now.

It would be difficult for India to progress on the path of sustainable growth unless inflation is controlled. Dr. Rajan has been a vociferous proponent of the need to control inflation in a sustainable way, for which several structural issues need to be fixed. Many of those are beginning to be discussed in terms of changing the rate of interest for small savings instruments (PPF, etc) which can go a long way in bringing down interest rates in the economy.

However, the global situation will probably continue to be volatile over the short term because of significant dislocations that seem to be happening in terms of currencies. The global recovery continues to be fragile, given that 7 years after the crisis, the Fed has neither been able to raise interest rates nor reduce the size of their balance sheet in terms of the QE they did to revive the US economy.

Having said this, we continue to maintain that we are in a very stock specific market, and that is our mantra – to focus on the company and its valuations. As long as we can do that, day in and day out, we should have reason to sleep well at night.

On the other hand, with lower inflation, companies will not be able to easily pass on price increases to customers. On the extreme side, companies like Reliance has seen a 32% fall in revenues in the last quarter as the selling prices of their products fall. Companies that would do well in a period of low inflation would be those that can grow volumes at rates ahead of real GDP growth, and not see a dramatic distortion in pricing power. The nature of companies that grew strongly over the past 6 years is likely to be very different from the companies that are likely to do well over the next few years, when inflation is likely to be lower.