The India Report
Comment of the Day

March 18 2010

Commentary by Eoin Treacy

The India Report

Thanks to Deepak Lalwani for his report which focuses on India's inflation. Here is a section
India's headline inflation exceeded expectations in February and nearly touched double digits. Annual wholesale inflation accelerated to 9.89% in February (vs. 3.5% in February 2009), the highest in 13 months. Contributing factors were food inflation remaining stubbornly high near 18% and manufacturing inflation accelerating to 7.42% in February from 6.55% in January as the economy gathers momentum. The RBI at its January policy review raised its end-March wholesale price inflation to 8.5% from 6.5% with an upward bias forecast earlier. Our forecast of 10.2% by end-March remains unchanged, although this may prove to be conservative. Rising prices have sparked street protests, backed by opposition parties. This has restrained the Indian government from pushing through reforms like relaxing fuel and farm price controls, despite the ruling Congress party not facing any risk of losing power nationally.

At its next policy review in April we expect the RBI to raise interest rates (reverse repo and repo) between 0.25 - 0.50% and the CRR by another 0.5% (after a massive 0.75% hike in January to 5.75%). With industrial output accelerating to 16.7% in January 2010 and wholesale price inflation expected to exceed 10% by end-March, the RBI is under pressure to contain inflationary pressures building up in the economy. Capacity utilisation is approaching highs last seen in 2007 and increasingly companies are reporting labour shortages, despite rising salaries. For example, recent reports in the press suggest 8-12% wage increases from April in major I.T. firms TCS, WIPRO and Infosys on an improved business environment.

Eoin Treacy's view High food price Inflation affects the poorest in society most and because these people have a voice in India's democracy, inflation can quickly become a sensitive political issue. Year on year comparisons, currently against January 2009's low reading, have probably flattered the inflation rate but sovereign yields signal underlying concern about inflation and the country's deficits.

The 10yr yield has been trending consistently higher over the last year and a break of the progression of higher reaction lows, currently near 7.5% would be required to question scope for additional upside.

Part of the rise in food prices can be traced back to last year's comparatively weak monsoon. Assuming a 'normal' rainy season this sector should find some relief this year. Sugar was a high profile example of a beneficiary of the poor monsoon, but has now completed a medium-term top. This story from Bloomberg illustrates that the Indian authorities are doing their utmost to acquire potash in an effort to boost this year's yield, suggesting that a multi-pronged approach to tackling inflation is being pursued.

The Rupee has also been allowed to appreciate against a basket of currencies in an effort to combat inflationary pressures. The Rupee Trade Weighted Index broke upwards from its 16-month base in January and a sustained move back below 96 would be required to question scope for further upside. Against the Rupee, the US Dollar topped out a year ago and has sustained an unbroken progression of lower rally highs since. A sustained move above R47 would now be required to question scope for further Rupee appreciation. It now also appears likely that interest rates can be expected to rise sooner rather than later.

The Sensex has been consolidating mostly above 16,000 since September in a steady mean reversion which was completed in February. It is currently rallying towards the upper side of the range and while this is the sixth consecutive week to the upside, a downward dynamic would be required for the 18,000 region to offer anything other than temporary resistance. The Bombay Banks Index has a relatively similar pattern.

While inflation remains an issue, measures are increasingly being put in place to tackle the threat. India continues to run budget deficits and relies on inward flows to bridge the gap but has an enviable growth rate, healthy reserves and a world class IT and service sector. The above charts suggest stock market investors are betting the economy will surmount its current challenges. Bond prices remain under pressure but if inflation is brought under control, institutional investors will be able to lock in an attractive yield in a relatively firm currency well below par; so Indian sovereign bonds are a sector to watch. If the Collective have any additional information on how to purchase these bonds, we would be happy to reproduce it.

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