Rupee has put the RBI in a fix - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Rupee has put the RBI in a fix 

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In this issue:
» Petrol prices go up as rupee falters
» Long term investing out of vogue?
» Is the shale gas boom over before it began?
» Europe's financial system is in a mess
» and more....

The Indian rupee has been on a bumpy road. The currency's steep fall in recent times has been a cause of worry for everyone. Its continued weakness is giving headaches to the policy makers as well. The fall has brought back to focus the issue of interest rates. In fact the decline makes a strong case for an interest rate hike. But will the RBI go ahead with it?

The arguments in favor of a rate hike are many. The consumer inflation figure for June 2013 has again started to trend upwards. It stood at 9.87% as compared to 9.31% in May 2013. The foreign fund outflows have gone up especially in the debt funds due to the increase in yields in US. And the rupee has fallen to all time lows. So the text book approach would be to raise interest rates. This would suck out the excess liquidity in the system which in turn helps support the rupee.

The other side of the story is the general economic health of the country. Growth is anemic. Demand, both domestic as well as external, has come down. This was visible in the latest industrial production and export figures, both of which registered a decline in June. Therefore a rise in interest rates would spell trouble for the economy.

It would also hurt the investment sentiment in the country, which in any case is low. Companies had been deferring their investment plans due to the high interest rates. Even when the Reserve Bank of India (RBI) cut down rates, the investment cycle did not really pick up. Therefore another round of monetary tightening may not bode well with the companies.

Little wonder therefore that the RBI and Finance Ministry are at loggerheads once more. The RBI has been pitching for a rate hike. The Finance Ministry on the other hand has been opposing the same. It could instead concentrate on doing its work in boosting economic growth by speed tracking reforms and removing investment hurdles; but then that's not what the Ministry seems to be concentrating on at the moment.

The question now is who will win? This would be answered in the RBI's next monetary policy announcement which is scheduled for the end of this month. Unfortunately there is very little that the RBI can do then.

Do you think the RBI will raise interest rates to support the rupee in the next meeting? Please share your comments or post them on our Facebook page / Google+ page

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01:20  Chart of the day
When it comes to investing we always stress that investments must be made keeping the valuations in mind. For this a popular valuation metric is the price to earnings (PE) multiple. We thought of applying this to the BSE-Sensex to see how valuations stand as compared to history. As seen in the chart, the BSE Sensex is currently trading below its 10 year average PE multiple. This would suggest that maybe the Sensex stocks are trading cheap which could offer attractive buying opportunities. But there is another explanation which is not very heartening. As such stock prices reflect company earnings. So the investors could be expecting earnings to decline which has led the Sensex PEs to dip below average. Investors would do well to dig a bit deeper to understand the reasons why their favorite Sensex stocks are trading cheap. If the explanation is simply a negative sentiment and not any fundamental issue, then it presents an excellent buying opportunity. But if the underlying reason is deteriorating fundamentals, then its best to give the stock a miss.

Data Source: ACE Equity

De-regulation of fuel prices was a necessary evil for India. While on one hand fuel subsidies are a bone of contention, inflation is no smaller demon. The pressure to curb fiscal deficit led to the government freeing up petrol prices. It did have a benign impact on fiscal gap. However, the same did not last long. The lethal impact of rise in international crude prices coupled with swiftly depreciating rupee made the hike in petrol prices grossly inadequate. As a result, the last 6 weeks have seen petrol prices being hiked 4 times. Needless to say, this will have an impact on inflation as well. The impact on inflation will, however, be more evident once diesel prices are revised too. Revision in diesel prices, though not implemented yet, is inevitable. Thus while the government's fiscal problems remain unsolved, the common man will struggle to cope with inflation.

Do you know what's the worst prediction in the history of stock markets? Well, we are of the view that this honour should go to a cover story that appeared in Time magazine way back in 1979. The title 'The death of Equities' was splashed across the front page of the magazine. It aimed to send out the message that equities as a long term investment option are virtually dead. To say that this prediction was a total fiasco would be an understatement. Starting the next year, the US equity market embarked on the possibly the biggest bull run in its history, lasting all of 18-19 years!

Not nearly this pessimistic but something similar seems to be going through the minds of Indian equity investors as well. This fact was brought to light by an article in leading daily where the writer argues how he received hate mails from people who've come to believe that long term investing is dead in India. Just as the writer, we don't think so this is the case. Just because markets have not returned anything in the last five years, doesn't mean future will be the same. And not matter how bad the business environment, there will always be companies out there that will be worth investing in. Thus, this might be the time when it really pays to be greedy when others are fearful. The Time magazine story is a prime example of this theory leading to spectacular results. However, enough care should be taken to ensure that one buys into fundamentally strong businesses and pays reasonable enough valuations for the same.

The shale gas revolution in the US has changed the global energy paradigm. With the promise of energy independence for the US, the dominance of the OPEC for crude oil supplies has been under threat. But has the world jumped to fancy conclusions a bit too prematurely. If an article in is to be believed, the shale gas boom in the US may have actually ended. Let us discuss some of the arguments presented.

For one, the domestic natural gas production in the US has been flat since January 2012. And it seems that it's going to be tough to maintain even current production levels. A certain survey of oil and gas wells in the US suggested signs of worry. After just three years, shale gas wells have been witnessing sharp decline rates ranging from 79% to 95%. What does this mean? Given such high decline rates, at least 79% of all shale gas production must be replaced every three years to just maintain the existing production level. Given that shale gas makes up around a third of US energy production (as of 2011), any major disruptions in gas supplies could have significant global repercussions. Moreover, US crude oil production has also gone flat since October 2012.

This brings to mind a very important lesson. The media and the markets in general have a very short term memory. They tend to raise the toast a bit too prematurely. Value investors must be careful while considering investments in new sunrise industries with no bankable precedents. While new sectors do present great growth opportunities, the risks involved should never be undermined.

What is the indication that investors would rather prefer the banks dead than alive? Well if the average price to book value of the entity remains below 1 time for a prolonged period it is quite a hint. As per Economist there are several banks in Europe that fall in this bracket. And one need not go too far to find why the distrust. The 2008 financial crisis was hardly a lesson for European banks. Instead of cleaning up their balance sheets, banks have used their well capitalized books to lend to more unproductive sectors. Private-equity firms that have raised billions to buy up distressed assets from European banks have also suffered. The regulators worry that instead of writing off or bad loans, the banks have been fiddling with excess capital. And the ECB's attempts to kick start growth with near zero interest rates have hardly succeeded. The Economist calls these entities 'Zombie banks'. Well, let us add that Europe is not the only place hosting this species. One would find plenty of them in the US, Japan, China and hold your breath, few in India too!

In the meanwhile after opening the day on a dull note Indian equity markets are now trading above the dotted line. At the time of writing, the Sensex was up by about 63 points (0.3%). Barring Indonesia and Malaysia, the other Asian markets closed the day in the green with markets in China and Taiwan leading the gains in the region.

04:55  Today's investing mantra
"When you locate a bargain, you must ask, 'Why me, God? Why am I the only one who could find this bargain?'" - Charlie Munger
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4 Responses to "Rupee has put the RBI in a fix"


Jul 16, 2013

If left to itself, the RBI, as has been seen in the past, can restore some realism and positive fundamentals. The politicians however may not care for anything beyond the next election. This is the same story whether in the states or centre. The easy option will be taken: hit the voice less , money power-less middle class with more taxes , direct and indirect, to make up for the largesse aimed at vote gathering.

This unfortunate situation, whether India, or any similar underdog country, doomed to be as such not due to any other reason than selfish self-preservation for family generations( MP,MLA,MLC,Party bosses etc etc) being the prime concern. The Nation, the people, development, growth etc are of no consequence in this ""GREAT AIM and NO HOLDS BARRED IMPLEMENATION OF THIS SELF PRESERVATION"". Parties and colors etc do not matter in thie Great March.. The SC judgement on (dis) qualification criteria for criminal background persons will be a real acid test.. Chances are the acid will be so diluted, it will have no effect.



Jul 15, 2013

Your analysis on why the rupee is depreciating is total nonsense!
Foreign funds inflow into emerging markets is NOT for interest rate arbitrage, but ONLY for growth prospects.

So raising interest rates will further accelerate the rupees decline.

Only a steep reduction in interest rates will bring back investors and strengthen the rupee.



Jul 15, 2013

Given the worst possible governance provided by the so called Doctorate PM, we all go with the RBI directions.


kamlesh bhatt

Jul 15, 2013

There is alittle case for either side movment. Reduction in no way seems feasible but the increase may be more detrimental to the sentiments for investments. However, for short term the moderate increase of 25 BPS may be helpful in attracting invesments in debt fund and may help in easing pressure on exchage rate.

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