Vijay Kumar Gaba

 No need to lose sleep over NASDAQ

When the independently priced cryptocurrencies were melting in the past few months, a stablecoin Tether (USDT) has been relatively much more stable. The value of USDT did show some volatility, but it was marginal in comparison to some other stablecoins like Terra and independently priced cryptocurrencies.

Being a technology challenged crypto illiterate person, I must outline my understanding of a stablecoin to make the context clear. In my understanding, a stablecoin is a crypto token which is backed by some financial or real asset, whose value is pegged to a fiat currency like USD. In simple terms, it is a tradable electronic entry priced in a fiat currency (like ADR of an Indian company tradable in US) which has an underlying asset like bonds. Theoretically, the price of a stablecoin shall move in tandem with price of the underlying; but in practice the movement in price could be less or more than the underlying.

Curious by the relative stability of USDT, I discussed the issue with some experts and crypto traders. While no one offered any satisfactory answer, the common thread was a conspiracy theory. It is commonly believed that a significant part of trade by “sanctioned jurisdictions” like Russia, Iran etc., is happening in stablecoins, USDT being the most popular one. Secondly, it is suspected that USDT is also a preferred currency for money laundering in many emerging economies.

Of course, I do not understand much of this, so I cannot make any intelligent remarks on this. Nonetheless, I must say that (i) tech enabled alternatives to gold are here to stay for long; (ii) the challenges to USD as the exclusive global reserve currency are rising gradually; and (iii) the global economy (and markets) might delink from US economy (and markets) sooner than previously estimated.

The experts have extensively talked about Japanification of the US economy (and markets) since the global financial crisis (GFC) hit the world in 2008 and the US Federal Reserve unleashed a torrent of quantitative easing (dollar printing). With massive monetary and fiscal corrections now becoming increasingly inevitable, in view of the rapidly changing (a) global trade dynamics and (b) global geopolitical balance; the probability of experts’ prognosis about the US economy coming true is rising gradually.

In my view, the forecast for the global economy and markets for next few years must account for these probabilities; howsoever small these probabilities may appear for now.

I would therefore not like to undermine the movement in NASDAQ and S&P500 to form my view on Indian markets and/or deciding my allocation to say IT services sector, for next few years. I would also like to read the predictions about a “lost decade for equities”, in relation to developed markets, especially US, without correlating it to India. I am also aware of the fact that equities in two major global economies China (15yrs) and UK (5yr) are already witnessing this phenomenon of lost decade; and this has not impacted the performance of other European and Asian markets materially.

In simple words, I do not see much merit in drawing correlations between GOLD-S&P500; Nifty-S&P500; and NIFTY IT-NASDAQ. The Beta of Nifty vis à vis S&P500 and NASDAQ shall reduce incrementally. There is no need to stay awake till late night to watch US markets.

In the latest episode of global inflation, ‘climate change’ is one of the key players. It has significantly impacted the supply and demand equilibrium of many commodities and services in a variety of ways. For example—

(a)   Notable changes in weather patterns have adversely impacted the crop production and livestock supply globally, resulting in sustained rise in food prices.

(b)   The global commitment to fight climate change has resulted in a significant rise in investment in clean energy and clean technology; mostly at the expense of investment in conventional energy. Most countries are aiming to achieve ‘zero emission’ in the next 3 to 4 decades. In the transition period, obviously the supplies of conventional energy shall remain constrained for the lack of adequate investment, tilting the scale in favor of higher prices. Sharp surge in coal and crude oil prices (even adjusted for logistic challenges due to Covid) is indicative of this.

(c)    The focus on clean energy and clean technology has resulted in an immediate rise in demand for non-ferrous metals, silicon, rare earths, semiconductors; whereas the additional capacities will come in due case as new investments are committed. Covid may have pushed the capacity building process further by 3 to 4 years. The demand pull inflation in these commodities and products may also sustain for some more time.

(d)   ‘Climate change’ and the efforts to control/reverse the adverse effects of climate change are resulting in significant displacement of labor in many areas, resulting in demographic imbalances besides demand-supply mismatch.

The farmers displaced due to adverse weather conditions due to climate change are struggling to get employment.

The skill requirements for the jobs lost in the ‘carbonized ecosystem’ and jobs being created in the ‘clean ecosystem’ are very different.

As per a recent McKinsey report, to achieve ‘net-zero’ by 2050, the capital spending on physical assets for energy and land-use systems will need to rise by $3.5 trillion per year for the next 30 years to US$9.2trn/year. The cumulative capital spending on physical assets for the net-zero transition between 2021 and 2050 would be about $275 trillion. A net-zero transition would have a significant and often front-loaded effect on demand, capital allocation, costs, and jobs.

The report highlights - (i) The transition would be felt unevenly among sectors, geographies, and communities, resulting in greater challenges for some constituencies than others. Developing countries and fossil fuel-rich regions are more exposed to the net-zero transition compared with other geographies; and (ii) As high-emissions assets are ramped down and low-emissions ones ramped up in the transition, risks include rising energy prices, energy supply volatility, and asset impairment.

The points to ponder, inter alia, are (i) whether the global economy is prepared and willing to tolerate the pain of transition for 20-30 years; or efforts would be made to find a balance by allocating adequate capital to conventional energy and technologies; especially hydrocarbons and food production; and (ii) who will bear the losses as trillions of dollars in extant assets become redundant? 

 “No brainer” or “mo’ brainer”

What should an investor make out of a situation - when the RBI governor makes a public statement, two weeks before a scheduled monetary policy committee (MPC) meeting, asserting that it’s “no brainer” to expect that the committee will hike rates in the meeting? Especially when this assertion comes a day after the government has taken some very effective fiscal measures to control inflation and less than 3 weeks after the RBI had announced an unscheduled rate hike.

To me, at first it sounded like a confident Central Banker in full control of the situation. He exuded confidence that (i) the external situation of India is strong and the RBI shall be able to manage the current account deficit (CAD) comfortably; (ii) the central government might not have to revise the fiscal deficit target projected in FY23BE since revenue collections are strong; (iii) there are clear signs of growth reviving as reflected in rise in imports despite higher prices and strong exports; and (iv) the RBI is in control of the yield curve and INR exchange rates.

However, on second thought, I feel that the RBI is perhaps as perplexed by the current economic situation (global and domestic) as anyone else. In fact the Governor himself admitted that the situation is volatile and dynamic. Till the February 2022 MPC meeting, the Committee assumed that the inflation is transient and there is no need to tighten the policy but the Russia-Ukraine war changed the dynamics and in April 2022 meeting it was decided to (i) withdraw accommodation; and (ii) hike the effective reverse repo rate by 40bps (that immediately lifted overnight rate by 40bps). Within one month the RBI made an unscheduled 40bps hike in Repo Rate, palpably to preempt INR exchange rate slide in view of the imminent US Fed Rate hike.

The question is when so many external variables, which are not under control of RBI, are operating at different levels, having unpredictable impact on the Indian economy, how could the RBI term a future policy decision “no brainer”?

The Governor admitted that for now inflation is top priority and not the growth. The government appears to be in full agreement with this stance of the RBI. The government has recently diverted Rs one trillion of capex (Road and Infrastructure) allocation towards price maintenance to calm fuel prices. The government has also raised export duties on steel and restricted the export of wheat. The government has also taken measures like hike in subsidies on LPG and fertilizers. Reportedly, the government is also considering limiting sugar exports. Higher cotton prices have reportedly hurt textile exports in the past few months. Recently, the government has also extended the free food scheme for 90million households by six months till September 2022.

Juxtaposing all these, I could deduct the following:

(a)   To control prices, the RBI and Government have decided to sacrifice growth. Higher rates may further delay the private investment recovery. This means the supply side constraints may continue to hinder the growth for longer than previously anticipated.

(b)   The measures taken by the government may hit exports and therefore widen the already worrying CAD.

(c)    The Forex reserves are already down by US$50bn in the past six months. Keeping yields lower and INR stable may require more USD selling by RBI, at a time when CAD is vulnerable. Obviously the external situation might not remain as comfortable as the Governor is asserting.

(d)   The primary factors driving the inflation, viz., extreme weather conditions; global supply chain bottlenecks; Russia-Ukraine war; and Sino-US tensions etc. are beyond the control of the RBI and might continue to put inflationary pressures on Indian economy. So it could very well mean marked stagflationary conditions for a wider section of the Indian economy.

In my view, we all lie in a flux and there is nothing which is “no brainer” at this point in time. The situation is too dynamic to predict anything with reasonable certainty.

Presently, there are two diametrical opposite views about the evolving global situation.

As per the first view, there are conspicuous signs of global growth slithering down as the inflation has begun to destroy the demand, except the food for which demand is largely inelastic. In the recent readings of composite leading indicators have expanded for only one fifth of the countries (vs over 90% in April 2022). PMIs for most developed countries are nearing July 2020 levels. The growth engine of the world, i.e., China is stuttering with the latest growth forecasts fading to 3.9 to 4.5%. The monetary tightening by a number of central bankers has already started to show some results. Consequently, the commodity prices have started to cool down and inflationary expectations should ease going forward. It is therefore likely that the present monetary tightening cycle may reverse much earlier than previously forecasted. This view thus assumes a broad status quo on the present global order.

The second view however assumes a radical shift in the global order. As per this view, the extant global order that is characterized by deflation, independent central banks, globalization, minimum government, rising share of corporate profits in GDP, longer cycles and lower volatility is coming to an end. The emerging global order is remarkably different. It shall be characterized by regionalization, larger socialist governments, pricing power with labor and commodity producers, lower corporate share in profit, high real rates and inflation and poor equity returns.

I am struggling to form a view that lies in between these two extremes.

(mo’ brainer (noun): A situation or puzzle or predicament that is more difficult than it at first seemed; the opposite of a "no brainer"; something that requires more than one person (i.e. mo' than one brain) to figure out.)

After US electing a “leftist” Biden to occupy the White House; Germany elected social democrat Olaf Scholz to the office of Chancellor, France reelected left of center Emmanuel Macron (first reelection of a president since 2002); Italy reelected Christian leftist Sergio Mattarella; and now Australia has elected a leftist Anthony Albanese as the prime minister. The ruling right of the center New Democracy party in Greece has been consistently losing support in opinion polls for the elections scheduled to be held in October later this year.

A number of Latin American countries like Chile, Mexico, Argentina, Bolivia, Peru, and Honduras have elected leftist leaders to lead their respective countries. The opinion polls are indicating that Columbia and Brazil are also most likely to elect leftist leaders in the elections to be held in May and October respectively. In Asia, the Chinese communist regime under President Xi Jinping has strengthened its position.

Moreover, to counter the egalitarian agenda of left of center parties, even the right of center parties like conservatives in UK, BJP in India, LDP in Japan and Yemina in Israel are increasingly resorting to socialist agenda to retain power.

The emerging trends clearly indicate that the rising income and wealth inequalities are driving the political narratives globally. Obviously, this narrative will gain further momentum as the monetary corridor tightens further and fiscal constraints begin more pronounced.

The recent cuts in excise duty on transportation fuel announced by the government of India must be viewed from this angle also.

Over the weekend, the finance minister announced a cut of excise duty on petrol (Rs8/ltr ) and diesel (Rs6/ltr) to cool down the inflation and provide relief to the stressed consumers. The finance minister stated that this cut will have a Rs one trillion impact on the central government budget. She also mentioned that the entire Rs one trillion will be met through reduction in Road and Infrastructure Cess (a part of Central excise on transportation fuel). It is pertinent to mention that the cut of Rs5/ltr in petrol and Rs10/ltr in diesel made in November 2021 was also met entirely through reduction in RIC. The November 2021 cut had an infra budget implication of rs1.2trn.

The union government has levied a Road Cess on sale of petrol and diesel in the union budget for FY99 to create a dedicated fund for construction of roads. The fund was later adopted under a law named Central Road Fund (CRF) Act, 2000. In the Finance Act 2018, the cess was rechristened as The Road and Infrastructure Cess (RIC) as the scope of the fund was widened to include infrastructure.

The Road and Infrastructure Cess (RIC) is collected and levied on specified imported goods and on excisable goods as specified in the Sixth schedule of the said Act. The said goods are motor spirit commonly known as petrol and high-speed diesel oil. The objective of RIC is to provide dedicated funds for development and maintenance of National Highways, railway projects, improvement of safety in railways, State and rural roads and other infrastructure.

The reduction in RIC means almost 10% cut in Rs.11.06trn provided for capital expenditure in FY23BE. This is equal to 75% of the allocation made for NHAI in FY23BE.

Obviously, the immediate relief to the poor from inflation is a higher priority than growth. As things stand today, the tighter monetary and fiscal conditions will continue to challenge the growth ecosystem in near future. This implies that supply side challenges that are threatening the global economy may continue to persist till a new growth paradigm emerges. In the meantime, the economic policy will continue to be a constant struggle to avoid stagflation.

The investors are finding themselves standing at a crossroad again. For seasoned investors this is nothing new, but for a large proportion of investors who have started their investment journey in the past 5 years, this is something new.

At this juncture everyone has to choose a path for onward journey. The options are rather simple –

(i)    Continue the journey in the north direction - Stay with the extant strategy and hold on to your investments.

(ii)   Take a right turn towards the East - Review and restructure your portfolio of investments in light of the new evidence.

(iii)  Take a left turn towards the west – Change the strategy and rebalance the portfolio in favor of Safety and Liquidity from Return previously.

(iv)   Turn around and move back in the south direction - Liquidate the whole or a substantial part of your portfolio and wait for an opportune time to begin the journey afresh.

The empirical evidence suggests that the vintage of investors and size of portfolios plays an important role in making this decision. The seasoned investors and/or investors with larger portfolios usually avoid the fourth option and prefer the options listed at (i) and (ii) above; whereas the newer and/or investors chose from the options (iii) and (iv).

In my view, choosing an option is prerogative of the individual investors. I am sure, they make a decision which they consider best as per their investment objectives, risk tolerance, and personal circumstances. The problem however occurs, in most of the cases, when the investors avoid, delay or precipitate a decision. Avoiding a decision makes you jittery portfolio values move beyond your risk tolerance bands; delaying or hastening a decision often leads to wrong decisions.

The question is whether it is an appropriate time to take a decision; or the investors may take some more time to decide the future course of action; or is it already too late to take a decision.

I believe that each investor will have to answer this question individually; and I can speak only for myself. In my view, it is a bit late to make the decision, but not too late.

I would however like to mention a few historical facts that might help my fellow investors in making an appropriate choice.

Prima facie, the market conditions today may appear to be similar to the conditions during dotcom boom, bust and resurrection (1998-2000-2004). Like the dotcom bubble, this time also the market rally was characterized by the new age businesses with undefined business models and negative cash flows for prolonged periods, commanding unsustainable valuations. Like dotcom bubble, the low interest rates in past one decade fueled the bubble and rate hikes caused the burst.

·         For records, Nifty had gained 127% (800 to 1800) in a short span of 15 months (November 1998- February 2000). It gave up all the gains in the next 18 months (September 2001). It took almost three years (November 2004) for Nifty to “sustainably” break past the 1800 level. In the present case Nifty gained 148% (7500 to 18600) in 19 months (March 2020 to October 2021). In the next seven months it has shed about 25% of gains recorded in the preceding 19 months. So, if we assume the present case to be a case of repeat of dotcom

·         It is pertinent to note that while Nifty recovered the losses during the burst in 3years, many market leaders took much longer to recoup their losses. For example, Infosys took 6 years (2006), Wipro took 20 years (2020) and Hindustan Unilever took 10 years (2010) to reach their high levels recorded in the year 2000.

The present economic conditions are substantially different from 2000. The central bankers had sufficient ammunition to support the markets in 2000. The US Federal Reserve cut rates from a high of 6.5% in 2000 to 1% in 2004 to support the economy and markets. The inflation was not a worry and the new growth engines in the form of the emerging markets, especially India and China, were emerging fast to support the global growth. In the instant case, however, the central banks have virtually no ammunition left to stimulate the growth; all the growth engines of the world are stuttering and inflation is a major concern for the entire world. After all, the world perhaps has never seen a recession while the interest rates are still so low.

It is therefore reasonable to assume that the market trajectory may also be different than 2000-2004. Considering that the cycles (rate, Inflation, growth, etc.) are now much more shallow than 2000s. The rates this time may peak at much lower levels. We may not see global growth at 5% in near future and therefore inflation may not last longer either. The markets may not revisit 2020 panic lows and also may not take 3years to breach 2021 highs.

Nonetheless, the valuation readjustment within markets may be material and lasting. The valuations for many new age businesses that have lost significantly from their recent high might continue to correct further. Many of these businesses may fail to sustain and become extinct. On the other hand, some old age businesses that have corrected to “cheap” range may regain some prominence. So it would still be in order to restructure the investment portfolios.

For the record, I chose option (ii) a couple of months ago and took a Right Turn.

The weather in India these days is as diverse as the country itself. There are severe floods (usually not seen in pre monsoon period) in North East; cyclonic storms in East and South East, torrential rains in South; drought in North and scorching heat in North and West. Power supplies are challenges; wheat has ripened early; sugar cane is drier; seasonal vegetable crops have been damaged.

Recently, some RBI officials reportedly told the parliamentary standing committee on Finance that RBI fears increased “dollarization” of the Indian economy due to popularization of cryptocurrencies. The representatives of the central bank reportedly testified before the committee that “…almost all cryptocurrencies are dollar-denominated and issued by foreign private entities, which may eventually dollarize a segment of the Indian economy. The cryptocurrencies could be a medium of exchange and replace the rupee in financial transactions, both in domestic and cross-border transactions, affecting the monetary system and undermining the RBI’s capacity to regulate capital flow.”

In this context it is pertinent to note that—

(a)   As per the latest available World Bank data, foreign trade accounts for ~38% of India's GDP. A substantial part (~86%) of this trade is invoiced and settled in USD; whereas only 5% of India’s imports are from and 15% of India’s exports to US.

(b)   It is estimated that approximately 60 to 65% of India’s foreign currency reserves are held in US dollar assets.

(c)    At the end of FY21, India had about ~US$570bn of external debt; about 21% of GDP. Out of this ~18% was short term debt (due for repayment in 12months). Though the composition of this debt is not readily available it is safe to assume that a significant part of this debt is denominated either in USD or currencies that are pegged to USD or are closely linked to USD, e.g., CNY, AED, SAR, SGD etc.

(d)   In the recent consumer price inflation (CPI) data (April 2022), about 20% of the total CPI inflation was imported inflation, caused by rise in global prices and depreciation of INR against USD.

This implies that a substantial part of the Indian economy is already “dollarized”. To that extent, the concerns of the RBI are valid and understandable. This also explains the “go slow” policy on rupee convertibility and stricter control over capital account.

As per Gita Gopinath, renowned economist and Deputy Director IMF—

“The greater the fraction of a country's imports invoiced in a foreign currency the greater its inflation sensitivity to exchange rate fluctuations at both short (1 quarter) and long (2 year) horizons. For the U.S. with 93% of its imports invoiced in dollars the consequences are far more muted than for a country like India that has 97% of its imports invoiced in foreign currency (mainly dollars).

When a country's currency depreciates the expectation is that it will stimulate demand for the country's products as it lowers the relative price of its goods in world markets. This is unlikely to be the case for many countries that rely on foreign currency invoicing for their exports. This does not imply that exporters in non-dominant currency countries do not benefit from a weaker exchange rate. They do, but it mainly works through increases in mark-ups and profits even while the quantity exported does not change significantly. The benefits of higher profits in a world with financial frictions can of course be large and raise production and export capacity in the longer run.”

The question is what India should do to avoid dollarization of the economy. Obviously, banning cryptocurrencies and controlling foreign currency transactions may not be sufficient. We would need to materially increase the invoicing of our exports in INR.

The Nobel laureate Robert Mundell propounded the Mundell-Fleming paradigm in 1999 to address this issue. As per this paradigm, to gain from the weakness in local currency (vs other currencies), the exports must be invoiced in local currency.

For example, if Indian exporters invoice their products/services in INR, their prices do not fluctuate often. In this case, depreciation of INR against the importers’ currency will immediately result in cheaper cost for the importer and therefore lead to demand shift towards Indian products/services. However, if Indian exporters price their products/services in USD (as is the case presently) the shift to Indian producers will depend upon the equation between USD and Importer’s currency.

The key for India therefore is to develop more bilateral relations where the trade could be conducted in local currencies, e.g., India exporting in INR and importing in the currency of suppliers. The bilateral FTA route being adopted by India in the recent past is perhaps the best way to achieve this goal.

The most interesting part of this changing paradigm would be how the bilateral trade relationship between India and China develops. China is one of our largest trade partners. Trade relations with China are obviously critical for India’s overall economic growth and development. The ideal outcome would be if we can reduce our trade deficit with China through mutual agreements, e.g., by increasing export of services, food etc.

 The macro economic data released last week produced further evidence of the Indian economy struggling with stagflationary conditions; notwithstanding the denial by various authorities.

Inflation impact widening and deepening

The consumer price inflation date for the month of April 2022 was a negative surprise. The consumer prices escalated at a rate of 7.8% (yoy) during the month. The higher inflation was, to a large extent, a consequence of imported inflation which added almost 2% to the headline inflation number. Though, the inflation due to rise in domestic prices at 6.4% was also no comfort.

With worsening current account (and depreciating INR); continuing supply chain disruptions; protracting Russia-Ukraine conflict; extreme weather conditions and tight fiscal conditions (little chance of duty cuts) and rising cost of capital – it is unlikely that we shall see any material easing in prices in the next few months; even though the headline inflation number begins to ease from October 2022 due to statistical reasons, as the high base kick in.

Contracting consumer demand constricting the growth

On the other hand, the recent data about the growth in Industrial Production raised many red flags. The IIP growth for 4QFY22 has come at a dismal 1.6% (vs 2.1% in 3QFY22).

The consumer goods production (both durable and non-durable) contracted 4.3% in March 2022, recording its sixth consecutive decline. This clearly shows the stress in the consumer demand. Growth in capital goods was a poor 0.7%. Manufacturing growth in March was also poor at 0.9% yoy. 

Normalizing for the sharp dip in 2020 due to the pandemic induced lockdown and subsequent sharp spike in 2021, India’s Industrial Production has been dismal in the past decade.

Poor suffering the most

Notwithstanding the claims of some politicians, the poor seem to be hurt most by the rising inflation and slower growth. As per the latest NSO data, the inflation rate is much higher in most populous states like West Bengal (9.1%), Madhya Pradesh (9.1%), Maharashtra (8.8%), Uttar Pradesh (8.5%0, Odisha (8.1%0 and Rajasthan (8.1%). These states may be home to a large proportion of the poor population in the country.

Kerala (5.1%) and Tamil Nadu (5.4%) are suffering relatively much lower inflation.

Besides, the real interest rates have fallen deep into negative territory in the past couple of years, as monetary stimulus to mitigate the pandemic effects has brought the rates lower while inflation has stayed high. Obviously the poor savers and pensioners who rely on meager interest income for survival are suffering a great deal.

The conventional wisdom guides that roads are meant for moving forward and trampolines are meant to get momentary high without going anywhere. Usually, the chances of reaching the planned destination are highest if the traveller takes a straight road. The chances are the least if they ride a trampoline. Walking on ropes may sometimes give you limited success.

Investors who jump up and down with every bit of news are only likely to lose their vital energy and time without moving an inch forward. Reacting instantaneously to every monthly or quarterly data, every policy proposal, corporate announcement, market rumor are some examples of circuitous roads or short cuts that usually lead us nowhere.

The developments in global financial markets in the past couple of years highlight that presently very few persons are interested in taking the straight road.

Taking the straight road means investing in businesses that are likely to do well (sustainable revenue growth and profitability); generating strong cash flows; maintaining sustainable gearing; timely adapting to the emerging technology and market trends; and most important consistently enhancing the shareholders’ value. These businesses need necessarily not be fashionable or be in the “hot sectors”.

In the Indian context, finding a straight road is rather easy for investors. Of course there are different viewpoints and strategies; having their own merits and inadequacies. It is possible that the outcome is different for various investors who adopt different strategies or take a different approach to invest in India.

For example, consider the case of investment in the infrastructure sector in India. Prima facie, it looks like a rather simple strategy. In an infrastructure deficient country like India, the case for investment in this sector should be rather simple and straightforward. But it has not been the case in the past 20 years.

Infrastructure has made money only for few

Infrastructure inadequacy of India has been one of the most common investment themes for the past few decades. However, more people may have destroyed their wealth by investing in infrastructure businesses or stocks of infrastructure companies than anything else. Especially in the past two decades, that have seen phenomenal development in infrastructure capacity building, the value destruction for investors in this sector has been equally remarkable.

There is no dearth of infrastructure builders who have become bankrupt with near total erosion of investors’ wealth who invested in their businesses. JPA Group, ADAG Group, Lanco, IL&FS, GVK, IVRCL, Gammon etc. are just a few examples. Their lenders, and the investors in their lenders, have been a colossal collateral damage too.

The fallacy in this case lies in the fact that while everyone focused on the “need” for infrastructure, few cared about the “demand”.

Indubitably, the “need” for infrastructure, both social and physical, in India is tremendous. However, despite significant growth effort in the past two decades, and manifold rise in government support for the society, especially poor and farmers who happen to constitute over two third of India’s population, the “demand” for infrastructure may not have grown at equal pace. The affordability and accessibility to basic amenities like roads, power, sanitation, education, health, transportation, housing etc., has improved a lot, but it still remains low.

As per a recent government admission almost one third of the population cannot afford to buy basic cereals at market price and therefore need to be subsidized. Only about one third of the adult population has access to some formal source of financing. Ever rising losses of state electricity boards and free electricity as one of the primary election promises, highlight incapacity or unwillingness of the people to pay for their power bills. The losses incurred by some of the most famous highway projects, e.g., Yamuna Expressway, highlights the low affordability to pay toll tax for using roads.

The optimism on the infrastructure sector in the decade of 2001-2010 might have been a consequence of overconfidence and indulgence of administration and corporates who sought to advance the demand for civic amenities to make abnormal profits. This was not only a classic case of capital misallocation, but also misgovernance by allowing a select few to take advantage of policy arbitrage. This has resulted in huge losses for investors, lenders, local bodies and eventually the central government also.

The investment in infrastructure companies’ stocks for a small investor is therefore a tight rope walk. They may achieve some success after a stressful balancing act to normalize the forces of greed and fear.

With over two third of the population struggling to meet two ends, all those statistics claiming “low per capita consumption or ownership” of metals, power, housing, personal vehicles, air travel etc. is nothing but a blind man holding the tail of the elephant. If we find per capita consumption of electricity of the population that has access to 24X7 electricity and can afford to pay full bill for this at the market rates, we may be in the top quartile of per capita electricity consumption.

The politics of “competitive majoritism” has also led to irrevocable government commitments towards profligate welfare spending. This has certainly provided some sustainable spending capability to the expansive bottom of the Indian population pyramid. This clearly indicates that the government finances are likely to remain under pressure for a protracted period. Therefore, in my view, capex and infrastructure themes may work sustainably in Indian markets only when necessary corrections are carried out. Till then it is the trampoline ride that will continue to give investors momentary highs, without taking them much distance.

The investors and traders, who jumped on this trampoline after listening to the enthusiastic budget speech in February 2022 promising trillions of rupees in infrastructure spending, would understand the best, what I am trying to suggest here.

I have been married for more than two decades now. In all these years I have deliberately maintained a safe distance between my personal and professional life. My wife Anandi, a post graduate in Hindustani Classical music and an amateur poetess has never shown any interest in the matters relating to finance. She finds it too “dry and mundane”. Last few days though have been a little different. To my surprise, Anandi herself started a discussion on stock market. At once, I could not fathom why she would be suddenly interested in what she always believed to be the mired world of finance and investments. But soon I realized the catalyst of this change- it was her cousin brother Anuj, who has apparently lost heavily in the recent collapse in the stock market.

If we have to list the reasons for the loss of growth momentum in our economy in the past decade or so, the following three would be amongst the top reasons:

There is an old legend. From time to time, numerous versions of this legend have been narrated by wise people to highlight the adverse effects of not admitting the mistakes early enough; indecision; and failure to assess the gravity of an adverse situation. One version of the legend goes like this—

Once a thief was caught stealing a sack of onions from a farmer’s house, and was produced before the magistrate. On asking, the thief first pleaded “not guilty”. After a trial the magistrate found him guilty of stealing and allowed him to choose his punishment from the following three options – (i) Pay five gold coins to the farmer; (ii) eat hundred onions from the sack he tried to steal; or (iii) get whiplashed hundred times.

The thief chose to eat the hundred onions, without giving it a thought, assuming it to be the easiest one. However, after eating just twenty five onions, he was in tears. His stomach started to burn and refused to take anymore. He begged the magistrate to change his punishment to a hundred whiplashes. The magistrate allowed his request and ordered his men to whiplash the thief a hundred times. After taking twenty five lashes his skin started to come off and pain started to become unbearable. He again implored the magistrate to stop his men and allow him to eat onions. The magistrate agreed to his request. He ate another twenty five onions and could see the grim reapers (Yumdoot) standing right in front of his eyes. He now pleaded to the magistrate to allow him to pay five gold coins. Had you stopped for a couple of minutes to think about the options presented to you, you would not have suffered so much the magistrate chided him, agreeing to his request.

The moral of the story is that if the thief had admitted his mistake early, the magistrate could have let him off with a milder sentence. He chose a sentence which he had no clue about, rather than opting for the clearly defined monetary fine. Also, despite suffering once, he still did not opt for the right option and suffered an avoidable twenty five lashes and twenty five more onions.

The situation of the Reserve Bank of India (RBI) is somewhat similar to the thief in the legend. It refuses to admit that it has been confused between growth and inflation for long. It also refuses to accept that in the present situation the factors driving the inflation are mostly beyond its control; and it can only manage a small part of the inflation by hurting the growth significantly and imperiling the financial stability!

Palpably, the out of turn rate hike by RBI is aimed to protect the INR. The fear of the larger outflows, as other central bankers hike rates aggressively, appears to have prompted the RBI to make a preemptive hike. The currency market though does not appear impressed by the RBI move, and INR has weakened to its lowest level ever. The outflows have continued in the equity as well as debt market, despite higher yields (bonds) and lower valuations (equity). The RBI might thus have wasted one important arrow (40bps rate hike) in its quiver.

The situation is vividly reminiscent of the current account crisis of 2012-2013. The INR witnessed violent volatility and outflows were strong in light of taper tantrums. The rate hikes at that time did not help much and we were very close to a balance of payment crisis. The RBI changed its approach in September 2014 and an imminent disaster was averted, but not without some serious damage to the financial stability and growth ecosystem.

I assume this time we will not be driven to the brink like 2013, and the crisis will be mitigated soon. For now we are eating onions only. I hope the economy will be spared whiplash and gold coins.

The Monetary Policy Committee of the Reserve Bank of India, in an unscheduled meeting on 04 March 2022, decided to hike the policy repo rate by an unconventional 40bps to 4.4%. Besides, the RBI also decided to increase the standing deposit facility (SDF) and marginal standing facility (MSF) rate by 40bps to 4.15% and 4.65% respectively. The cash reserve ratio (CRR) for the banks has also been increased by 50bps to 4.5%. This action of the RBI is not entirely surprising, given that the consumer inflation (CPI) rate in the country has been consistently running close to or over the RBI’s tolerance band for the past many months.

The decision of the RBI came a few hours after an unscheduled 25bps hike by the Royal Bank of Australia (RBA) and a few hours before the much anticipated 50bps hike by the Federal Reserve of the USA (the Fed). With this over 55 central bankers have hiked their respective policy rates in the past 10 weeks. This includes about one half of the members of G-20. Interestingly, the countries struggling with financial crises and growth like Zimbabwe (2000bps); Sri Lanka (700bps) and Pakistan (250bps) have tightened most aggressively in the past 10weeks. Besides, Australia, the commodity exporters of Africa and Americas have also hiked the rates. Russia and Singapore are the only two notable countries that have cut the policy rates since March 2022.

Evidently, inflation is the overriding concern of most central bankers at this point in time. Even the central bankers like US Federal Reserve and Reserve Bank of India which were insisting that inflation is transient, being a consequence of the temporary supply chain disruptions due to the pandemic, and could be surmounted by focusing on growth, are now according higher priority to price stability rather than growth. Both the Fed and RBI have hiked rates despite palpable slowdown in the growth in recent quarters, and consensus downward revision of the future growth forecasts. Obviously, the policy decisions lacked conviction and thus did not elicit the desired response from commodity, currency and bond markets.

The Fed itself blunted its attack on inflation by ruling out aggressive hikes of 75bps in the forthcoming policy meets. The RBI governor was conspicuously apologetic while making the announcement. It is pertinent to note that bonds and currency markets were already anticipating these hikes and had discounted some of the impact beforehand; these actions were mostly expected to have “signaling” value for the markets only. By communicating a weak signal both the fed and RBI have disappointed the markets.

RBI takes a ‘curved’ path

For the past four years, the RBI had been following a straight path. It gave top priority to economic growth, followed by financial stability and price stability in that order. The commitment to this order of priority afforded it the strength to handle the pandemic led crisis remarkably well, while aiding the government efforts to stimulate the growth. Both the RBI and the government were seen operating in perfect tandem, unlike in the preceding years when the monetary and fiscal policies were often at odds.

With this decision, the RBI seems to have deviated from the straight path to take a curvaceous road. Under the pressure to stay on or ahead of the ‘curve’, the RBI has distorted its order of priorities.

It is a common belief that most of India’s current inflation has been caused by (a) high prices of imported energy, edible oil and industrial metals; (b) higher fruits & vegetables prices due to poor weather conditions; (c) rise in food prices due to higher support prices and (d) global supply chain disruption impacting the production. There is no sign of over speculation in the domestic commodities markets. There is no sign of overheating in the housing or auto markets. The credit growth has been below normal for past three years. It is difficult to explain how, in the Indian context, a rate hike could calm down the prices, except by destroying the demand that itself is below normal. In fact only a couple of day ago, the RBI itself has forecasted that it will take 12 more years to fully recoup the losses suffered by the economy due to the pandemic.

On the negative side however, higher rates will further constrict the already tight fiscal space for the government. Higher interest expense would have to be compensated by lower spending, as in a falling growth environment hiking tax rates may not be a viable option. A stronger INR (due to higher rates) could negatively impact the exports that have been the only bright feature in the struggling Indian economy in the past two years.

…ignoring the latest empirical evidence

The most unfortunate part of this episode is that the RBI has not learned anything from history. During 2010-2014, when the economy was still struggling to overcome the effects of the global financial crisis, the RBI started hiking rates unceremoniously from 5% in March 2010 to 8% in January 2014. These hikes not only negatively impacted the recovery, but also weakened the financial system materially. The rate had to be cut by 50% to 4% in the next 6 years to stabilize the financial system and bring the economy back on the growth path. It is important to remember that the RBI was cutting rates consistently from January 2015 (except two hikes of 25bps each in June and August 2018). Only the last 40bps was cut as a pandemic stimulus in March 2020.

…and trampling on the nascent economic recovery

A 40bps higher policy rates, in conjunction with the 50bps hike in CRR and 80bps hike in the effective reverse repo (including 40bps done in April MPC meet) will definitely tighten the money market, impacting the working capital facilities and short duration personal loans. Given that we are in a lean season, the impact on the overall credit market may not be visible immediately, but the impact on growth may be felt in 2HFY23. The higher cost of capital may further delay the elusive capex recovery.

Impact for equity markets

A popular saying in the equity markets literature says, “Market stops panicking when the central bankers begin to panic”. If we go by this saying, we should be expecting a bottom in the equity markets very soon.

I am not sure if this saying will come true this time (even though I am secretly wishing for it). In my view, the markets will eventually call the bluff of central bankers and force them to revert to the straight path. Till then I expect the equity markets to stay volatile and range bound. Obviously, this market is for the swing traders to make money. For investors, it may be advisable to follow another popular market saying – “Sell in May and come back in October”.

For the past two years, I have been highlighting to the readers of this blog that almost two third of the Indian population is experiencing conditions that qualify to be termed stagflationary. Their incomes have been stagnant or declining in many cases, while their cost of living has risen materially.