Invest Without Emotions
Previously, we looked at how inflation adjusted returns for the NIFTY, from 1991 through 2016, was 5% annualized. How does it look for bonds?
At the short-end of the curve, it looks like inflation ate away all of the returns… and some more.
Code and charts on github.
What do you think is the annualized inflation adjusted NIFTY 50 return is from 1991 through 2016? Hint: Gross returns were ~13%
It was 5%
The Midcap index was created much later. So to keep things on an even keel, if you run both NIFTY 50 and NIFTY MIDCAP 100 between 2002 and 2016, it turns out that their real returns were about 7% and 13% respectively.
So,
Code and additional charts are on github.
Is there a relationship between inflation and stock returns in India? A recent study that looked at monthly data between 1994 and 2014 shows that there is no significant pro-cyclical inter-dependency between inflation and stock returns.
However, the paper does not present the results of any statistical significance tests. This leaves the reader at the mercy of trying to interpret pretty pictures of wavelet transforms.
Raghuram Rajan, after having said “If you do a Volcker, you kill the supply side, and then you are in a bad situation,” seems to be itching to do a mini-Volcker.
On his arrival at the RBI, Rajan established a Trojan horse in the shape of an expert committee tasked to advise whether the central bank’s somewhat elastic growth-inflation mandate should be changed to a narrow inflation target.
The Urjit Committee came back with a recommendation that the RBI should aim to reduce headline consumer price inflation to 8% within a year, 6% within two years and 4% (+/- 2pp) thereafter.
This chart from a recent Credit Suisse report show how ridiculously difficult this is going to be:
The problem is that India is a convoluted policy mess. Food & energy account for 57% of the total CPI. We have a Minimum Support Prices (MSP) for food that have a greater impact on food & energy inflation than repo rates.
More from the Credit Suisse report:
Supply-side shocks (e.g. unusual weather patterns) and government policies are often more important drivers to the extent they impact food prices in particular. According to our analysis, if, for example, the government were to lift minimum support prices for key foodstuffs by an average of 20% at the beginning of the 2014/15 fiscal year, rather than another 6% as in 2013/14, this would more than offset the disinflationary effect of a 100bp repo rate hike.
The brain-trust at Credit Suisse expect three more 25bps repo rate hikes by the end of the 2014/15 fiscal year. If this were to occur, what would become of the banks? From FT:
If one makes sane assumptions regarding what % of the currently stressed assets of the banking system will have to written off and if one factors in incremental Basel III capital requirements over and above that, Indian banks need around US$40bn to regain Balance Sheet strength. That amounts to 2% of GDP.
Inflation targeting, without fiscal reform, and without considering the fate of banks and lacking any progress on labor reforms will brew a potentially toxic stew. Good luck to whoever wins the elections.
Inflation to India is what deflation is to Europe. The persistently high inflation since 2006, especially food prices, have raised serious structural economic concerns. It is no secret that RBI has failed miserably in controlling price pressure with its so-called interest rate hikes. While RBI has lost its face, the common man has lost his ‘weight’.
Several factors like capital stock deficiency, demand-side drivers, import price pressures, embedded inflation expectations, weak monsoon, etc have played their part at various intervals to keep food prices elevated for an elongated period of time.
For the second month in a row, consumer price inflation- a more realistic cost-of-living index as it captures retail prices- remained at double-digit level in May.
Retail inflation rose 10.36% in May, marginally up from 10.26% in April. In cities, it was even higher at 11.52%, compared to 9.57% in rural India. The Wholesale Price Index (WPI)-based inflation in May stood at 7.55%.
The reason why RBI’s monetary tool has been ineffectual in taming inflation is because the current food price-driven inflation is fuelled by supply side constraints rather than just aggregate demand.
Although current year production of cereals has been very strong, food inflation is still in double-digits as food consumption patterns have changed with the populace moving towards high protein food like milk, eggs fish, vegetables from cereals. While measures like centrally-sponsored welfare schemes, high subsidies, sixth pay commission wage hike, etc have boosted disposable income and created demand for goods and services, the government has been unable to increase supply to meet the rising demand. Inadequate infrastructure and lack of manufacturing capacity and poor stock management has meant grains continue to rot while humans go hungry.
Instead of rooting for repo rate cuts, Pranab and co would do well to increase agricultural output and productivity to alleviate pressures on food prices. These would include a focus on technology, improved supply chain, water management, rural infrastructure, agricultural diversification, and private sector investment in marketing and agro industry. Reducing farm subsidies and raising productivity is needed to reform the agriculture sector.
Sustained wage pressure (thanks to MGNREGS, the government’s flagship employment programme and higher crop MSPs) has kept food price inflation high even in years of record food production as was the case in 2010-11.
Import price pressures have also been a crucial factor for overall inflation. Inadequate pass-through of international crude oil prices has failed to curb wasteful consumption leading to a high degree of suppressed inflation. Any rise in global commodity prices will put upward pressure on prices in India.
Recent RBI survey pattern reveals high inflation expectations among Indian households. Since food price hikes are driven by supply-side shocks, it has led to speculative behaviour by traders, thus feeding into high inflation expectations. The onion crisis in late-2010 is a stark example of this.
Also, the steep hike in minimum support prices (MSP) of various kharif crops last week and in the last five years have added to the structural uptrend in food price inflation and complicated RBI’s job. The sharp MSP hike, at a time of high inflation also shows the utter lack of policy co-ordination between the central bank and the government in achieving price stability.
While hyperinflation may be a matter of history, India is in the midst of an inflationary spiral that threatens to push economy into further chaos.
