»5 Minute Wrap Up by Equitymaster

On This Day - 18 NOVEMBER 2013
No hedge for double digit retail inflation

In this issue:
» Eurozone recovery seems to fade away
» FM wants different models of banking
» Auto industry recovery seems far away
» Is Dr. Copper sick?
» and more....

If you do your own grocery shopping, you will notice that the prices of food items keep going up. Retail inflation as measured by Consumer Price Index (CPI) rose an annual 10.09% in October. The main reason for this was the sharp increase in vegetable prices which shot up 45.67% year-on-year. It is this sharp increase in food prices which pinches aam admi the most. It is this increase which leads to the erosion of savings of a retired person, since it is a necessary expense and can't be postponed.The increase in the retail inflation is quite a disturbing trend. What is even more disturbing is that the expectations of prices coming down because of good monsoon seem to have faded away. But more bad news seems to follow. The RBI has said that the retail inflation is likely to remain around or even above 9% in the months ahead. The government on its part has given up the fight. It seems they are waiting to pass this burden to the next government after the general elections.

So how can a common man insulate himself from double digit inflation? Well, there are no quick fix solutions to this. There are hardly any short term financial instruments available to hedge the risk of inflation. Even gold, despite its inflation hedging properties, cannot be relied upon to offer commensurate returns in very short term. More importantly it may not be wise to have a disproportionately high exposure to gold.

The RBI is planning to introduce bonds linked to consumer price inflation for retail investors. The rate of interest on these securities would comprise a fixed rate plus inflation. Interest would be compounded half-yearly and paid cumulatively at redemption. But there is no guarantee whether these bonds will succeed? The RBI had earlier this year launched 10-year inflation-indexed bonds, which were linked to Wholesale Price Index (WPI). But it had failed to attract much interest from investors.

High inflation spells bad news since it means the RBI will hesitate to cut interest rates, a step needed to boost economic growth. Consumers will have to keep paying large chunks of their income every month towards repaying housing loans, even as the cost of food and petrol rises and the prospect of decent salary hikes recede because the economy is struggling. Inflation is also really bad for your retirement planning because your target has to keep getting higher and higher to pay for the same quality of life. In other words, your savings will buy less.

Thus unless the government undertakes bold reforms and solves supply side issues, India might be stuck with high inflation for a significant amount of time. Meanwhile investors may have no tangible solution to park their short term funds in safe, inflation hedging instruments.

Has double digit food inflation burned a hole in your pocket? Let us know your comments or post them on our Facebook page / Google+ page

 Chart of the day
Indian banks have witnessed a significant jump in bad loans over the last few years. The profitability of the banking sector, particularly public sector banks, has been adversely impacted. This has resulted in lower provision coverage ratio (PCR).

First, let's try and understand what PCR means. PCR is a measure that indicates the extent to which the bank has provided against the potentially non recoverable loans (NPAs). A high ratio suggests that additional provisions to be made by the bank in the coming years would be relatively low (if gross non-performing assets do not rise at a faster clip). The RBI wants banks to increase provisions for bad loans. Internationally, provisioning is 70-80% which is far higher than 30-40% in India. The RBI is also planning to frame new rules that would incentivize banks that were proactive in early detection and resolution of NPAs.

Provision coverage for stressed assets

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The Eurozone has been struggling for a stronger foothold since the crisis broke out nearly 5 years ago. Things did seem to be looking better a few months back when the zone reported a growth of 0.3%. This came as a relief for the 17 member bloc which had seen a de-growth for the previous six quarters in a row. Everyone thought that this was a sign that things would be on the mend thereon. But the latest numbers from the region have cut short the celebration. The growth this quarter is estimated to be just 0.1%. Though the number is not strictly comparable to previous quarter's numbers as there is a seasonal one-off related to Germany; however there was a considerable slowdown seen in other countries as well. This brings back the question as to whether the Eurozone's recovery is sustainable or not.

The zone still has countries laden with debt that have been handed out bailouts after bailouts. Though they have enacted austerity measures in lines with the bailout requirements, however even then their financial situation is precarious. Add to this the high levels of unemployment weak investments and tight credit conditions. As per CNNMoney, the European Central Bank (ECB) has stated that it would take measures including further interest rate cuts to help revive the situation. This means that the money printing exercise of ECB will most likely continue. However if the ECB and the Eurozone takes a cue from US, they would realize that money printing just postpones crisis. It does not resolve it.

No cloning of existing banks. No place for non innovators. No place for those not wanting to reach out to the unbanked population. These are some clear cut guidelines cited by the Finance Minister. While it is at the RBI's discretion to give out the much sought after licences for new banks, the FM has made his choices clear. The preference of giving out banking licenses to non banking entities seems to be the clear mandate. Existing industry players however do not quite agree with him. That differential regulation may make the sector extremely risky is one of the key concerns. As per Mint, Axis Bank Chief Shikha Sharma has also pointed out how differential regulation led to the subprime crisis in the US. Plus if the new entities are allowed to not comply with the CRR and SLR norms for few years, the exiting entities will be under tremendous pressure. Now it is left to the RBI to take the final call. We are quite certain that the central bank will take an independent view as against buckling under the FM's pressure.

The auto industry has been facing headwinds for quite some time now. While FY13 was a terrible year, FY14 is proving to be no different. Volumes across most segments in the auto space, most notably passenger vehicles and commercial vehicles has been rather poor. In the passenger vehicles space, while car volumes have been tepid, there has been a considerable slowdown even in the growth of utility vehicles (UVs). The volumes of the latter grew at a stupendous rate in FY13 at a time when all other segments of the auto industry were adversely impacted. However, the story this fiscal has been different. Firm interest rates, hike in excise duties and diesel prices has meant that the demand for UVs has waned. Even the festival season did not see demand pick-up like it did in the previous festive seasons. For the entire auto industry, it does seem unlikely for a recovery to take place before the fiscal ends. But there are hopes that growth should pick up FY15 onwards.

So, how are copper prices doing? Why just copper you would ask. Simply because historically, there hasn't been a better barometer of the economic health than the price of copper. If copper prices are inching upwards, chances are the economy is doing well and vice versa. In fact, it is this attribute of copper that has won it the title of a Doctor. So, whenever you need to look into the health of an economy, the movement of copper prices could help you arrive at the right answer. And how's copper doing these days. As per marketwatch.com, the basic industrial metal has been making lower highs and lower lows for quite some time now.

What is shocking though is that this has coincided with the S&P 500 making new highs. Therefore, if the old relationship still holds good, either copper or the S&P is set for a huge reversal. Now given how the US equity market is being supported by cheap liquidity with very little economic improvement on the ground, we believe a huge equity market correction awaits us. So rather than copper prices inching up, a bear market in equities looks like a greater possibility. What do you think?

After opening the day on a firm note, the Indian equity markets continued to trade in the positive territory. The BSE-Sensex was trading higher by around 316 points at the time of writing. Barring Japan, the major stock markets in Asia were trading firm. However, the key European stock markets opened on a negative note

 Weekend investing mantra
"In this business, if you're good, you're right six times out of ten. You're never going to be right nine times out of ten" - Peter Lynch

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