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Inflation at 11.4% is meaningless

Inflation at 11.4% today and the folks on CNBC are jumping around in excitement. I usually don’t watch business news, but today I have this viral fever and couldn’t help but watch the gyrations of the anchors as they squirmed to explain the inflation. All of them blamed oil price increases, and one of them said non oil stuff is also going like crazy, and they even predicted that at this rate inflation would be 16% by the end of the year. (If it grew 0.4% every week)

This is a stupid extrapolation. This 0.4% was this week. Last week the jump was 2% (at that rate inflation will be 100% in a year) and before that we had spells of rising inflation and slowing rates – so there can be no conclusion of this dramatic sort.

11.4% itself is meaningless. It is so high it is ridiculous. To even make a statement that it is higher or lower is of no consequence – at an absolute level inflation about 8% or even 6% is too high. After that it doesn’t matter how high, you have to do whatever it takes to bring it back down.

What is important is the policy reaction. The first reaction is to raise rates – not very effective because the bond market in India is not very liquid. (Issued bonds go down when rates rise, and that affects both short and long term portfolios and issuing companies – but we have very little liquidity in our bond markets)

The other reaction, and I really hope this happens, is the destruction of the dollar rupee equation. Take the dollar to Rs. 35 by selling, if necessary, even half the 300 billion USD we store for no real reason. That will destroy exporters, but inflation is a bigger problem – choose the better evil.

As crude goes up in value – today’s rates were 142 – we will have even more inflation. But that will go away – this is starting to look like a panic rise, almost. Iran has 20 VLCCs sitting in the persian gulf looking for delivery – and given that it is heavy sour crude, not much takers. It’s only when RPL comes online that more of this crude can be refined, but even that is only 0.66 million barrels per day (versus 85 million barrels per day consumed worldwide). Still the increase in refining capacity will bring down price somewhat, but for that RPL has to be operational.

Lastly, there is the entire issue of the next wave of the credit crisis – and if Lehman and Citi are affected there are bound to be more outflows.

So what do I make of the picture. Bad. Very bad. While there may be pullbacks, unless something dramatically good happens, we are going down further.

Disclosure: Am short the Nifty.

  • Rohit Chauhan says:


    how do you short the nifty ? due you use puts or sell futures ? what kind of trading costs and premiums are you looking at.

    Somehow for stock specific puts i have found that the premiums are too high and most puts are for 3 months. so not very useful if you are bearish in the long run.

    if i am not mistaken there no LEAPS available in the indian market


  • Ninad Kunder says:

    >Hi Deepak

    I didnt get the connection between inflation — policy action — interest rate hike — bond market liquidity — ineffectiveness of the action.


  • Chaitanya says:

    >Hi Deepak,
    A very nice blog as usual. Could you explain how increasing interest rates would help reduce inflation if bond markets were liquid ? I heard Ajay Shah say the same thing on CNBC but was not really able to understand the connection.


  • Anonymous says:

    >Hello Deepak,
    Strong disagreement here. If we sell USD like hell, sure INR moves up, who knows to the levels you predict. But a direct consequence of this is that the IT and Textile pack are affected badly. I care a damn if stock market goes bust, but I do care about the 2 million+ households whose bread earners work in these industries. Do note that it’s from here it all started, and if this is affected this 8%+ would shortly become close to 2%. I do not think the policy makers are in any position to do something like that. At any rate UPA is losing for such horrible mismanagement of fiscal and if it dares further, it’d b routed.


  • Deepak Shenoy says:

    >Arpan: It’s 2 million households there, versus 100 million households everywhere else. As I said it’s the cheaper evil.

    They will make money at 35 also. And the majority of the impact is already through when teh dollar went to 39. The residual impact is too little in comparison with risign inflation.

    A rising rupee WILL NOT raise the stockmarket. But it will contain inflation. The funda is not to protect the stockmarket at all – who cares about that – but to control inflation.

    You give textile and IT more credit than they are worth. They account for less than 10% or even 5% of our industry and they had ALREADY slowed down. Textiles grew at around 5% a year, and IT at around 22%. Most of the growth comes from oil, agriculture, manufacturing, infrastructure, power, commodities, fin services and FMCG, who aren’t negatively impacted by a falling dollar. (in fact most are positively impacted)

    I believe we will actually be able to get better growth with a falling dollar. That is an inflationary consequence though, but lags by much more (a year or more).

  • Deepak Shenoy says:

    >Rohit: I would short the nifty futures, buy puts or sell calls depending on the situation. Today puts are a little expensive and the futures are at a 40 point discount, so I would choose to sell calls instead.

    You can do LEAPs too – options are open until Jun 2011! For every three and 6 month intervals that is.

    ninad, chaitanya: I have responded in another post.

  • Ninad Kunder says:


    I assume a significant part of your blogs views are in concurrence with Ajay Shah’s ” Useful but Ineffectual” article in the Financial express.

    I dont think in India the issue is about the bond market, the issue is about the ineffectivess off interlinking of the bond market with the currency market on a real time basis which also needs a effective derivatives market to dissipate policy action on a real time basis.

    It is to do with the broader philosophy of a more managed monetary economy with controls on capital account convertibility that the RBI has maintained thru the years. One can argue either ways on this. Some of the crisis that the west faces, we have managed to be immune to bcos of relatively closed economy and hence not as well integrated with the currency and bond markets worldwide.

    In my opinion Mr Reddy has relatively done a good job for the last few years by being ahead of the curve in terms of policy action. Far better than Mr Bernake who has always been behind the curve resulting in markets dictating Fed action as opposed to the other way around. The RBI has thru policy action has gradually deflated the real estate bubble without too much pain in the system. There is still some way to go but it has been managed in a gradual manner. Really speaking the RBI has fallen behind the curve this time because I don’t think any of us anticipated the supply side shocks in the world economy and that prices would moves as fast. Inflation this time is more supply driven and not demand driven because of high prices of commodities namely oil. The RBI is doing a fine balancing act of trying to slow down demand without bringing the economy to a grinding halt. RBI’s actions are not dictated bcos of oil and steel going up 20 % in a fortnight. Imagine if RBI pushes up interest rate to 11- 12 % to compensate for inflation and next week realises that Oil has corrected 20 % down. It is not going to move interests rates based on market fluctuations and weekly inflation data. Mr Bernake is better at doing that :-).

    It would take a broader policy framework that interest rates are heading upwards and work its way up gradually.

    Coming to your suggestion that we take rupee to 35 by selling some of our reserves. What reserves are we talking about?. The RBI is sitting on dollar reserves which are short term in nature FII. Hedge funds etc. We are not talking about FDI here. Look at the currency depreciation with a few billion dollars going out of FII money going out. Our current account deficit is widening and the fiscal condition is not very great. If I m hedge fund manager what would I do if the RBI takes the rupee to 35. I will exit India big time. Forget stock or the Index a straight 20% return on the currency, what more do u want. We would have a stampede of people wanting to exit. And I m sure somebody like Mr Soros would be happy to bring the RBI to its knees like the Bank of England. We had a strong currency over the years not bcos of some great current account surplus or FDI but bcos of money coming in the stockmarkets, real estate etc.

    At 35 to the dollar we are not talking about reduced profitability of the export sector (and BTW that includes textiles, agriculture, gems and jewellery etc and not jut IT) we are talking about wiping out quite a few of these industries. With a current account deficit that is widening we will not have dollars to buy oil leave alone buy it at a lower price to reduce inflation. China which is sitting on a current account surplus should be the one appreciating its currency and not us.

    Lastly I m not a economist so I could be way of the mark here 🙂


  • Deepak Shenoy says:

    >sorry Ninad, I disagree. Firstly about the bond market – if you have an active bond market everything else will fall into place. Our bond market is nowhere near active.

    I don’t agree that we have been insulated BECAUSE we have been a closed monetary system. It’s a correlation that is confused with causation. I would argue that even if were were an open economy we would have been as immune or even more immune than otherwise. I would have been on your side in 1997 because we were undercapitalised compared to the western funds but today we indeed have a much more stable system.

    I agree that Mr. Reddy has done better than, for instance, Mr. Greenspan or Mr. Bernanke, but Reddy’s had the cushion of a closed market too. Last year they fought inflation by pushing the rupee down. Why not this time? It takes just a little more effort.

    Coming to the rupee: You overestimate FII flows compared to others. FIIs correspond to less than 30% of inflows, compared to NRI remittances, exports and FDI. Considering that the rest of the money isn’t flowing OUT, we can easily forego the FII money with less than 30% of reserves (some of which is Indian owned and routed back through hawala and thus also not likely to move out of the markets)

    Our reserves at a time like this are INCREASING. This is stupid. We should be actively walking in to sell dollars like crazy. With the amount of reserves and potential leverage we have even a 100 times Soros cannot create that much of an impact. The scale is THAT big. We are SOOOOO huge today that the RBI can easily topple any fund worth its salt that wants to take it on.

    Who cares if the FIIs exit at 35? They’ve done most of their exiting already. I am increasingly getting the feeling that RBI is simply waiting for these guys to exit and then will push it down. It’s a sensible thing to do.

    And note: we have NEVER had a strong currency. The RBI has always tried to weaken it, and the argument against open markets was that it would immediately rise 20% against the dollar. Only last year has it strengthened and that because the RBI stopped selling the rupee as aggressively as it was.

    The not-having-money-to-buy-oil argument has no water. With about a 3-4 billion dollars transacted per day in the currency markets I would imagine that it would take the RBI about $1 billion per day to move it up slowly, and at 10 paise a day it could move to 35 in 80 trading days, and if you factor in a few days here and there, you’d get a five month timeframe to 35. We’d spend about 100 billion.

    Consider oil. We import approx 855 million barrels a year (gleaned from an import bill of 77b, for a price of 90 per barrel). That may go up to say 900 million barrels, considering decrease in consumption due to raised rates, slowing growth etc. That will bring our import bill to $126 billion, and with reserves aroudn 200 bn we are comfortable at 1.5 years of oil.

    At 35 inflation would be vastly controlled, as costs of literally everything else, in rupees is down.

    China will also aggressively sell dollars, mind you, but they are in a horrible situation as their reserves have reached 1.8 trillion.

    We have to do it before they do it. Otherwise there will be war.

  • Ninad Kunder says:


    I think we are condemned to disagree :-).

    To quote you ” I don’t agree that we have been insulated BECAUSE we have been a closed monetary system.It’s a correlation that is confused with causation. ” and then you say
    ” I agree that Mr. Reddy has done better than, for instance, Mr. Greenspan or Mr. Bernanke, but Reddy’s had the cushion of a closed market too”.

    I see a dissonance in these statements.

    Coming to your arguement that FII money is just 30% of reserves. Well the remaining isnt long term sticky money. FDI largely in areas like real estate and remittances. 30% still is a large sum.

    And NO sir RBI is not SOOOOO big. The Bank of England was much BIGGERRRRR and SOROS was much SMALLER than the size of hedge funds are today. And its not one player but the entire market which turns in a particular direction. The lead player just sets the direction. It wont happen to us bcos we are a regulated economy.

    Who care if FII’s exit at 35?

    I do for starters. A few billion dollars of FII’s exit has bought the markets grinding down to these levels. 100 billions dollars is a lot of money. I dont think there is somebody on the other side to take that liquidity. Stock markets will tumble to unprecedented levels resulting in flight of risk capital. Corporate investment will come to zilch overall sentiment and bring the economy to a grinding halt. So we are saying low inflation at the risk of zero growth. That the RBI can manage today also. Raise rates 13-14 % and they will do that.

    Just a small by product of 100 billion dollars of FII money moving out.

    And why are we doing all this to keep the Rupee at 35 to control inflation. We wont have infaltion anymore we will have stagflation.

    Coming to the oil part, I didnt mean literally that we wont dollars to buy oil tomorrow. But you cant have a strong currency and a ever expanding current account deficit. Goes against the basic principles of economics. Forget economics just plain logic. If we cant earn to pay for what we spend then we have to earn more and spend less.

    So we increase exports with a weaker rupee and make imports expensive so that we reduce consumption and not the other way around. Our current account deficit so far have been balanced by capital account flows. Since you are suggesting that capital account flows turn negative then we might as well start earning on the current account.

    And if FII’s make 20% on the currency then somebody has to lose 20%. Its a zero sum game. So on 100 billion dollars the government will lose 20 billion dollars. Well that is enuf money to subsidises oil till it corrects.

    As always I am not a economist so I will might be way of the mark :-).

  • Deepak Shenoy says:

    >Ninad: There is no dissonnance – that we have a closed system I agree, but that we as an economy have done better because of a closed system I don’t. Reddy has done better than Bernanke because of a closed system is relative overperformance as central bank heads, but that has nothing to do with how our economies have performed. We have not been insulated because we are closed – that we are closed has only helped central bank policies. The distinction is important to make – central bank success isn’t directly relative to how an economy succeeds. Remember how Volcker was successful in the 70s when the economy tanked TWICE.

    FII money or what I call the 30% is the only hot money floating around – the rest isn’t going anywhere, and of that 30% the large majority that had to go has gone. I doubt you or I can prove our stuff with data, so let’s just wait and see.

    The RBI statement is a laugh – please check the fund sizes that you talk about and how much these guys allocate to EMs and how much money is involved with the INR/USD. You’ll find the RBI is really really really big now. And we are not a more “regulated” economy than say the UK or the US – we just don’t have free currency convertibility. IF they open that up that’s great – but if they choose to have it closed, they should beat the dollar down.

    Bank of England – I read what happened leading up to the event. BOE didn’t have the strength at the time or the reserve to handle the market, and later when it did it wasn’t inclined to participate (meaning it didn’t care)

    I find it surprising that you blame the FIIs for this fall – they weren’t responsible by their taking out money. They haven’t taken out as much from this markets as have the retail investors and brokerages! The non-FII bit of this market is much more responsible. And if mutual funds and Indian money finally get their act together they can easily override the FIIs exiting. FIIs control very little of the market mate, and a large chunk of the FII money is Indian money that’s routed through outside. So in reality there is not much of an “external exit” issue.

    Stagflation is an interesting problem to have, but given the amount of black money in the Indian market an easy solution comes to mind: offer another amnesty scheme for the black conversion and suddenly money supply increases dramatically. Other western countries don’t have that liberty.

    I don’t really understand the issue with a wide current account deficit. All you need is someone outside to finance the deficit like America has done for what, 50 years? And our deficit can be plugged if our exports get more inelastic with the USD/INR equation (basically to go up the value chain). We will never go up the value chain with a weak rupee, and therefore need a few years of a widening deficit to prod industry to move. If we don’t do it now we’ll never do it.

    And capital account flows don’t need to be negative! They can be positive with the dollar at 35. In fact it is more likely they will flow in at 35 than out. We won’t have a current account surplus for a while but that I don’t see as a problem because everything now is relative to someone else and literally everyone else has a bigger problem.

    The government loses on a short term measure – which governments should not care about as inflation is a long term problem. But the loss is notional, not real – as the forex reserve is a piece of paper that is dependent on a foreign currency’s strength anyhow (meaning it could drop 20% regardless, and in today’s world, looks very likely)

    I have a strong feeling that we are going to see the dollar down as the RBI will have no alternative, and political compulsions arise to curb inflation – and dollar devaluation is the fastest method.

  • Ninad Kunder says:


    Issue with the current account deficit is unlike the US which is the biggest economy nobody in the world will sit to fund us. And incidentally the issue in the US is that the US has had a party all this time by spending more than they can earn.

    The current account deficit kept widening and the rest of the world ( China, OPEC) kept lending to the US by keeping the surplus in dollar assets.

    The US dollar is the currency of the world. In a ideal scenario the US should devalue the dollar so as to reduce imports and make domestic industry viable.

    It wont happen because if the dollar loses its stability, capital will fly out of the dollar assets resulting in chaos in the world economy with no alternative strong currency in place. Also a dimishing of the US clout. The Euro was supposed to be a competitor to the Dollar but it hasnt really delivered. There are some OPEC countries that are beginning to ask for payments in Euro so as to derisk from the Dollar.

    The US is in its current mess primarily as it is not able to earn as much as it spends both on the current account as well as on the domestic fiscal front.

    Anyway I think its best that some third person adds a different perspective to this discussion else we will wind up going in circles :-).


  • Deepak Shenoy says:

    >ninad: I’m not sure that no one will be willing to fund us 🙂 Going forward, there has got to be spending economies that the world loves, and why not Indian and China. Yeah, not right now, but it’s going to happen going forward, at least partially.

    Actually this current mess has literally nothing to do with their current account or trade deficits. That problem will only come if the dollar fails as a reserve currency (or the entire concept of “reserve currency” becomes invalid) If anything the problem is that the US has printed way more money than required, and that other countries have hoarded the extra.

    The dollar is going down, and the US is beset by internal problems to tackle it fiercely; in the unwinding process the definite loser is the dollar. Countries like ours will run to gold or even a broad currency hedge – JPY, AUD, Yuan Renminbi, Dinars etc.

    Unfortunately what we talk about is primarily prediction – it’s not obvious what will happen. I remember our last argument on Rohit’s blog on ICICI when it was at the 900 levels – maybe I was right in that it had more to go, and maybe you will be right in that it will recover to higher levels in a couple years. What we are discussing here is even more long term so it’s impossible to counter 🙂

    But it’s always good to have an intelligent argument! My thanks for that…

  • Ninad Kunder says:


    Like I said earlier we are condemned to disagree 🙂 as we did on Rohit’s blog on ICICI.

    But I think we agreed on Prof Bakshi’s blog in the oil prospecting discussion :-).

    Well the pleasure was mine and it kept the weekend interesting. So ciao till we meet again on some discussion.