New government's magic wand

In the animated movie "Over the Hedge", as the animated characters try to rob food from the humans, there are many hilarious scenes. For instance in one scene the tread mill is pointed at and “RJ” one of the characters says *That* gets rid of the guilt so they can eat MORE FOOD! FOOD! FOOD! FOOD! FOOD! FOOOOOD! So, you think they have enough?

RJ: [everybody nods] Well, they don't. For humans, enough is *never* enough! And what do they do with the stuff they don't eat? They put it in gleaming silver cans, just for us!

Food and excess food is the case in some of the western countries, and we need that kind of solution to solve some of our problems. Limited supply of food, not because we produce less, but because we mismanage transportation from warehouses to people's plates- has resulted in high food inflation. It is hoped that the new government will solve this problem.

In the latest bi monthly monetary policy announced by the RBI, it has kept the “aspiring to fly” interest rates static. The indicative interest rates that RBI uses to signal the direction of interest rates is the REPO rate (It is the rate at which Banks could borrow from RBI). This has been kept static at 8%.

The comments were interesting to suggest that if directionally inflation heads down; there could be room for an easier policy. This could mean lower interest rates.

The hope or comfort factor is; with a stable government at the centre, better fiscal consolidation and food supply management should keep the price increases limited. What could go wrong on this assumption? Maybe rain? With predictions of El Nino- a weather effect that leads to drought in parts of Asia and failure of the south west monsoon in India, there is a possibility of lower produce and higher food prices.

What did the bond yields do and where would it end up?

The 10 year benchmark bond moved down by 7 basis points from 8.665% to 8.599% as the market started anticipating that in the latter half of the year, there could be rate cuts.

The way ahead for the yields would depend on the supply of new paper. Any increase in additional borrowing in the budget to pay for last year’s unpaid subsidy bills will be viewed negatively and the rates could again move up. Given the level of fiscal deficit, unless some strong steps are taken in the budget to curtail it, the supply of new paper will be copious and would be a source of worry. Bond holders may demand higher yield to compensate for fear of potential increase in inflation. (High fiscal deficit meaning more expenditure than income) would lead to the bond holders to demand higher compensation.

Stock markets and ground realities

The stock market was happy with the announcement and the markets remained buoyant and had one more reason to support their new found love for the Indian market.

While manic markets are where they are, the ground realities are still tough. From my recent meetings with companies, this is what I have to share:

•  The good news is that almost most of the companies that I met indicated that the animal spirits- meaning consumers desire to spend is coming back, confidence levels are high. However they do not see numbers significantly improving before March 2015.

•  High wages are still a problem.

•  Markets may think that, infrastructure spending would pick significantly and private capital expenditure will boom, but banks indicated that, they may not see significant credit growth for at-least three to four quarters.

•  The smarter banks are likely to again question the viability of every stalled project. It could be as simple as asking the project managers to explain the rationale for certain assumptions including power tariffs and gas prices.

•  The most excited companies were the internet companies. They seem to have found access to unending source of money supply and have no responsibility to generate any profits.

•  While NREGA implemented by the earlier government could have slowed down the pace of urbanisation, it could now pick up, if the current government puts better controls before doling out the NREGA amount.

Conclusion

The excitement is palpable, and one could hope to see higher GDP growth. In any case at Quantum we never believed in doomsday theory for India. Our view was that India could grow at 6.5% in the long run but we should identify good managements, invest at good valuations to generate good returns. Throwing these views out of the window only because India has a new solid government and all problems will be solved by a magic band, is being a little naïve.

Datd Source: Bloomberg

Above article is authored by Quantum.

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