|»5 Minute Wrap Up by Equitymaster|
On This Day - 8 AUGUST 2014
The real reason why inflation won't go away
In this issue:
Without getting too technical, Friedman's statement simply means the following. Whenever, the quantity of money in an economy increases faster than the GDP prices will rise. This, we believe, is the real long-term cause for structural inflation. Here we are not referring to the short-term spikes in food prices due to hoarding or the delayed monsoon. By 'structural inflation' we mean a general rise in the price level. After all, what does a movie ticket have in common with pulses? Nothing at all but the prices of both has multiplied over the years. This cannot be due to bad weather, high oil prices or speculators. Nor can it be explained by wars in the Middle East. The real reason is the supply of money which has increased over the years at an annual rate above 15% for several decades. The Indian economy, on the other hand has grown at a far slower rate. This has led to a constantly rising cost of living in the country.
Now we all know that the US government has run huge deficits for several years. The US fed has helped out by printing money whenever needed. The Quantitative Easing (QE) policy is just an example of this. But what about India? It is interesting to note that the Reserve Bank of India (RBI) has funded more than one-fourth of the government's borrowing program in the last few years. Why is this important? Well, this money from the central bank has helped the Indian government spend far more than what it could have otherwise. It has allowed the government to transfer huge amounts into welfare schemes. A lot of this money was siphoned off and never reached India's poor. Thus the quantity of money kept on increasing at a much faster rate than India's growth. This has led to India's structural inflation problem. So does this mean that the RBI must share some of the responsibility for this? We don't believe so.
In India, it is the government that decides how much it is going to borrow. This amount of borrowing in turn will determine the increase in the quantity of money. Thus, unless the government gets a grip on its own finances, the money supply will go on increasing. Short-term measures like tinkering with customs/excise duties and imposing the Essential Commodities Act on speculators will not solve the problem. The RBI governor Raghuram Rajan has quite rightly stated that India must solve this structural inflation problem as soon as possible. Otherwise, the cost of living for the common man will keep increasing year after year. Even corporates will not be spared. Structural inflation tends to last across the entire economic cycle. During periods of high GDP growth, even firms with poor pricing power will do well. However, when the down turn hits, only the most cost efficient firms with strong pricing power will survive to create long term wealth. So far the Modi government has shown its intent to control spending but we haven't seen many concrete measures being implemented. History will remember the previous UPA government as a failure on the inflation front. We certainly hope that this government's legacy does not end up the same way.
So, what's the conclusion? Well with India's market cap being 70% of its GDP currently, the market is just about fairly valued as per the indicator. Important to add that the long term average stands at around 72% and when the ratio goes up above 100%, like it did in 2008 when it touched 102%, alarm bells should start ringing. However, there does not seem to be any such concern for the time being and investors looking to invest in say index funds, can still walk away with good returns from a long term perspective we reckon.
It may be worth mentioning here that of the total cement capacity in the country, over one-third capacity comes from south India alone. Factors such as the political crisis in Andhra Pradesh, severe power outages and overall economic slowdown have severely impacted cement sector growth in the region. As per an article in Economic Times, the cement industry in the south has grown at a meager rate of 1% CAGR over the last four years. Many players have been making losses because of low capacity utilization rates and high costs. Whether the property developers are right about setting up their own facility is a different matter. But these developments certainly highlight the troubles engulfing the cement sector in the southern part of the country.
A recent research by a team of economists has revealed that rural Indians investing in cows and buffaloes could be acting rationally. That's because cows could well be trading at their bottoms now. Readers may help note that cow prices, like equities are quite volatile. During drought years, fodder could be scarce and thus profits can be low. Going by the same logic, during non-drought years profits could be high. And with monsoons covering India by now, the fear of drought has died down. As such, cows could give good returns now.
Basically, cows are an asset whose return varies depending upon fodder availability and monsoons, the same way like equity return varies with fundamental factors. The rural Indians know this pretty well. And are actively buying and selling cows thereby generating stock like returns. The only difference being their predictive power is more accurate as there are limited factors that influence prices of cows than equities.
Chinese banks have also been demanding higher collateral to prevent the risk of bad debts swell. Notably, the bad-loan ratio for Chinese banks has reached a record high. Besides, the shadow banking system has been constantly raising its ugly head. Moreover, the sanctity of Chinese data releases is also questionable. Therefore, it is a long way to go for Chinese banking system to overcome the formidable challenges.
Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement
Disclosure & Disclaimer: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. The Author does not hold any shares in the company/ies discussed in this document. Equitymaster may hold shares in the company/ies discussed in this document under any of its other services.
This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the consent of Equitymaster.
This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or has reached any individual in such country, especially, USA, Canada or the European Union countries, the same may be ignored.
This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Our research recommendations are general in nature and available electronically to all kind of subscribers irrespective of subscribers' investment objectives and financial situation/risk profile. Before acting on any recommendation in this document, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the securities referred to in this material and the income from them may go down as well as up, and subscribers may realize losses on any investments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation of an offer to buy any security or asset in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his behalf taking any decisions based on this document.
As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.
Equitymaster Agora Research Private Limited (Research Analyst) 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: email@example.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407