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Thoughts on the Recovery


I’m going to be thinking aloud.

The recovery in the last year has been great. Just one year ago today (May 18), the market was up 18% on post-election hysteria. The Nifty went from 3684 on Friday, May 15th to 4,330 on Monday, closing first for an hour when it hit the circuit breaker at 10%, and then again at the 15% level, and for the rest of the day. We have NEVER hit the upper circuit before, only the lower circuit multiple times.

Even from that high point, we are up over 15% on the Nifty today at 5070. And the Nifty has hardly been reflective; the Nifty Junior has moved from 6,600 to nearly 11,000 – a 67% gain. Midcaps have gained 100, 200 and even 500% in the last year.

Some of this has been because of good fundamentals worldwide. The easy supply of money has helped in recovery in terms of GDP for the US and in China; that helps because there’s demand for our goods, reasonably cheap imports and a healthy supply of capital. Within India, inflation inched up over the year as the recovery took hold.

But do we have problems? Greece’s problems have now become Europe-wide, and the Euro is at 1.23 to the dollar, pointing to parity soon. That will change the game – Europe is a big importer of Chinese goods, for instance, and that will change Chinese costs considerably. Europe exports a lot to the US too, and the lowered currency will only help. Yet, if there is a debt restructuring or a default in the Euro zone, I expect capital flows to move out of India and likely into the US.

The other thing with Europe is the Euro breaking down. There are rumours that Germany was forced into the bailout because France said they would quit the Euro otherwise. Germany, though, is in a great position to quit the Euro. They have to pay 123 billion euro to finance the bailout now. That is nearly all in a black hole. Their exposure to European debt is probably 500 billion euro. If they quit the Euro they will lose probably a good portion of that (the countries may not pay Germany back) but it might seem lesser than the potentially unlimited bailouts they will need to continuously fund. Getting back to a Deutschemark is not an unviable option at all, and I’m sure the German voters by now are aware of that.

And is China slowing down? We can’t say right now, because that country restricts news from flowing freely. Their markets have been falling – another 5% yesterday – to 2,600, now down nearly 20% from the recent high of 3,164 in mid-April. That, the papers say, is because China is tightening in the face of growing inflation, which could be as high as 3%. Of course we in India find that ridiculous – we have around 10% inflation with 8.5% GDP growth; that China can have 3% with 9% GDP growth is like, so expected. So if China’s in any way married to reality, inflation will go up much higher, they will need to tighten a lot more and it will destroy that real-estate bubble they have. That in turn will reduce the demand of commodities – cement and steel mainly – for which China has built capacity nearly to the moon and back (they have more cement capacity than the next three combined). Those cement companies will try to flood the international markets with the cement, if possible, and with Europe doing austerity, US home prices not quite recovering and most of Asia not in a position to handle that level of cement supply, will only crush prices. Or, as is probably more likely, introduce massive duties on Chinese cement. China then responds with restrictions on other things like investment and  finance, their largest import. That is a game changer, both for the world and within China. The reason China’s been calm in the last twenty years is their growth story; change that, and will there be civilian unrest, and therefore demands to unify the nation militarily if required? That is scary, because one of the countries they can go to war to “unify” their people is – India. That’s a dark thought, I know.

India is also seeing the re-emergence of a real estate bubble of sorts. Mumbai and Delhi have seen price rises, and serious increases in capacity – I personally get 10 messages a day for properties that are, in relation to Delhi, in outer space, but they’re constructing like there’s no tomorrow. Unfortunately there may be no tomorrow for those properties, if European debt suffers and China gets really slow.

Now for the other side of the story. Imagine the European bailout works. The banks worldwide that have bought Euro sovereign debt suddenly find themselves being paid in full, and are seriously capitalized. They’ll flood money into the largest and most stable companies – large caps in the US and Europe, while contracting SME and individual credit. Even hedge funds will get “allocations” and funds from banks. A small portion of that will flow to India, taking equities to crazy highs like the cheap US money has done in the last year. (Anyone who says our 100% growth in the last 18 months was purely because of local growth is kidding himself – fund flows are the A-one-primary-reason, both for going down and coming back up) It will fuel inflation, and force higher interest rates, which don’t work, and then serious capital inflow restrictions. Eventually cheap money finds the nearest crisis, money starts flowing out and the capital inflow restrictions hurt us because they stop it coming back in to stem the tide. We react late, and by that time we already have high inflation, extremely low markets, and have no choice but to get into a recession to fix things – we can’t try quantitative easing with high inflation.

It’s hard to predict how high we’ll go before we fall, so there’s no point acting on pure speculation. The idea is to figure out things that can happen, then look for signals that they are happening. We have the luxury of driving through our lives looking only at the rear view mirror, so we have to keep our senses sharp.

This is only a thinking-aloud post. I have no idea if the above scenarios will occur, but it’s just statements I try to tie together with logic and avoid thinking “oh, they won’t let this happen”.


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