Unloved and unwanted: Indian markets cornered - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
Unloved and unwanted: Indian markets cornered A  A  A
30 AUGUST 2013

If India - or any country - has any illusion of a global coordination and global effort to work as one planet (which was the order of the day in a post-Lehman environment) they would be wise to take heed of what senior representatives of the US central bank had to say. At the recent Jackson Hole conference in Wyoming, USA the Head of the Atlanta branch of the US Federal reserve correctly pointed out that the Fed was accountable to US citizens and that Fed policy was based on what was good for US economy - not based on what the impact would be on other countries".

Those G-20 meetings were obviously photo ops in which the leaders of the developed world could show their global credentials and get all the naive heads of Emerging Market countries to stand by their side in their hour of need. Now that the US economy is showing some semblance of normalcy, it is time to dust off the unwanted and go back to the "local" mandate song.

Local politicians to blame
The fault, as Caesar would have said, lies not solely in the Fed, but it lies in us. Charmed by the QE tricks of the Fed, Indian politicians went to sleep at the wheel and stopped taking any steps to make the local economy stronger or to reduce its financial dependence on global portfolio flows. Finance Minister Chidambaram was busy using his oratory powers to talk up markets but hot air only goes a limited distance (see Graph 1 below). From August 1, 2012 (when he became the Finance Minister) through August 27, 2013 the S&P BSE-30 Index gained +5.5% in INR but has lost -11.4% in USD against a decline of -1.1% in the MSCI EM Index

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Graph 1: The Chidambaram Premium deflates (S&P BSE 30 Index from August 1, 2012 till August 27, 2013 in INR and in USD; compared to the MSCI Emerging Market Index in USD)
Source: Bloomberg

India imports gold and oil
The current account deficit is due pretty much to India's thirst for oil and gold: fuelled by the distrust that most Indians have of the so-called Indian "industrialists". For many, the Indian elite represent robber barons who have successfully stolen their savings - ably supported by the financial firms with well-established credentials in global markets. Indians yearn for gold since IPOs and corporate bonds have been unreliable.

Graph 2: Current Account Deficit - excluding imports of oil and gold -
is steady at a surplus of 3% to GDP
Source: RBI, Bloomberg

Another source of demand for US Dollars has been the elaborate and inconclusive battle between the environmentalists and the cheerleaders for go-go-growth. Iron ore mining has been banned. Coal mines are not connected to railway tracks so, though India is rich in coal, it imports coal (Graph 3). This mismatch of approximately USD 12 billion per year has added 1% to the current account deficit, as a percentage of GDP.

Graph 3: Export of iron ore no longer pays for import of coal
Source: CMIE/Monthly data

Rupee flat on its back
With this combination of a demand for oil, a demand for gold (due to lack of faith in India's capital markets), and a policy log jam that adds to the import bill, the recent sell-off in the Indian Rupee is not surprising. But its velocity - and ferocity - is. The forward rates would indicate that the INR will weaken further (Graph 4). But the forward rates are more a function of traders running in where they see weakness as opposed to a fundamental argument for the weakness.

Graph 4: INR Forward premia
Source: Bloomberg

The Real Effective Exchange Rate of the Indian Rupee may be closer to USD 1 = 55 (Graph 5). The blue line of the actual fx rate tends to sway around the red line of the theoretical REER.

Graph 5: INR is undervalued in REER terms,
which suggests an INR rate of Rs 55 per USD
Source: RBI, Bloomberg; data used is RBI 36 country REER

But markets don't always care about the underlying theory.
The markets know best - at least for a while.

As long term value investors, we can feel the moment to buy a truckload of Indian equity is approaching.
The recent weakness in the Indian Rupee and the sharp sell-off in many stocks have seen an emergence of value.
We are not yet "upping" the weight allocation to India for international clients but, with a little bit of patience, the stocks of companies we like run by managements we can depend on may come our way in the next few weeks.
No, we're not there yet...but...stay tuned...its possible we may turn bullish on stocks pretty soon.

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Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.

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3 Responses to "Unloved and unwanted: Indian markets cornered"


Aug 31, 2013

i already posted my comment but i can not find it where it has gone?this is my second time bitter experience for posting comment on your article

Like (1)


Aug 31, 2013

for what reasons gold is imported through canalizes agencies and why govt of india do not allow private businessman for buying petrol and diesel in majority of countries in the world how we allow rbi governor to temper dollar in his own discretion instead of making fully float currencies what almost all countries are doing why we do not accept full convertibility if i am not mistaken the present finance minister promised step by step and he forgot his promised time for full convertibility is over

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Aug 30, 2013

Everyone blames the other. Those who afford never care about energy efficiency, and everybody knows the Indians' appetite for gold. As we need to import oil to run this country, is it not logical to ban import of gold at least for the time being. And, find a way to bring those unproductive small stockpiles of gold from the bank lockers by way of offering incentives like removing capital gains on sale, as suggested by some people.

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