Binary Outcome for India?

Remember the alarming collapse of the Rupee in August 2013? Remember those dire predictions of the pandits at that time? It was indeed a perilous moment with the Macro story of India coming virtually unglued. We have been and remain fervent believers of the Micro story of India, the fundamentally sound structure of the economy and the entrepreneurial drive of the Indian people. So back then we looked for a buying opportunity in Indian stocks & the Indian Rupee, the terrific opportunity that often arises when the tsunami of selling exhausts itself.

The financial markets delivered that opportunity on August 28, 2013 and we brought it to the attention of our readers on August 31, 2013 via our article Indian Rupee, an existential battle. In that article, we highlighted a large bet on India by an institution – a purchase of 1.125 million shares at $13.10 of EPI, an exchange-traded fund of Indian stocks. The Rupee closed on August 28 at 66.86 to the US Dollar.  It was a great time to get back into Indian stocks & in the Indian Rupee. How great? Just look at the chart below.


The Indian Sensex reached a new all-time high this week to close at 21919.79, a 16.7% rise from August 28, 2013. The Rupee has also rallied 7% from that day to close at 61.09 this Friday. And EPI, the ETF bought by that smart institution at $13.10 on August 28 2013, closed at 17.79 on Friday, a rise of 33.76%.

But is this really an Indian rally? Didn’t all emerging markets rally from August 28, 2013? Yes, they did but nowhere as much. In fact, emerging markets have been hurt badly so far in 2014. Currencies in darling EM countries like Turkey & Latin America have taken a hit. Brazil’s stock market is down 2.69%, China is only up 2.59%, Indonesia is only up 5% while India is up 16.7%. Similarly the Indian Rupee is up the most among major emerging market currencies.

This is really remarkable because investors are literally fleeing & abandoning emerging markets.  Look at the chart below from Michael Hartnett of BAC-Merrill Lynch:

                      4m outflows from EM equity & bond funds now ranks in the worst 0.05 percentile
                                    source: BofA Merrill Lynch Global Investment Strategy, EPFR Global, Lipper

In contrast, global investors have been piling into Indian stocks & so in the Indian Rupee. Why? Has the Indian economy improved so much since August 28, 2013?

Indian Economy

Unfortunately, the Indian economy is almost stagnant relative to its growth rate of the past few years. Consumer demand, the core strength of the Indian economy, is visibly weak. Walk around in Mumbai and you see signs that we have not seen before like a health care provider cutting its price by 33% for Valentine’s day.



Remember India is a country where demand has always outstripped supply. The current slowdown extends to the lowest levels of service. Tiny outfits like the ironing service (above right) that charges Rs. 5 (8 cents) for every garment used to busy all day until last year. Now they sit on their hands at least half of the day.

The reason is clear, we were told. The 8%-9% growth in India came from 4%-4.5% in consumption and 4%-4.5% in capital investment. The latter has virtually disappeared with Indian industries & businesses refusing to invest capital in India in today’s horrible policy environment. This has put a downward pressure on incomes. Combine weakening incomes & unemployment with unrelenting food inflation and you understand why consumer demand has taken a big hit.

Apparently rural spending, another core Indian strength, has been severely hurt as well.  In many rural areas, according to an expert on CNBC Mumbai, many eat only one meal a day at 3 pm. Why 3pm? Because “it is early enough to forgo lunch and late enough to forgo dinner”.

All this sounds awful and frankly it is. So why is money pouring into the Indian stock market?

Waiting for May

As Steven Schwarzman, chairman of giant investor Blackstone, told CNBC Mumbai in late January,
“there is some sense of pause in the country while they are waiting for the election”. He is talking about the national elections scheduled for April-May 2014.

The Indian stock market shot up 5% in past 4 days this week simply because the date of this election was finally announced by the Election Commission this week. This was a much bigger move than the previous rally that took place in early December on the BJP victory in state elections. Both show that the rally in India is based on the hope of the outcome markets want.


(Sensex – Feb 28 – March 7, 2014 courtesy  (Sensex – Dec 1 – Dec 6, 2013 courtesy

The Indian slowdown we discussed above is pregnant with hope, passionate hope that India will finally get a government that is focused on Indian development, a government with a track record of delivering electricity, water to rural India, a government that understands India cannot grow without substantial capital investment. a government that really understands that government has no business being in  business.

All these hopes are centered on the expectation that Narendra Modi, the successful Chief Minister of Gujarat, will become the next Prime Minister of India. This will a major change in itself because almost all of the previous Prime Ministers have been
politicians without any track record of governing.

Blackstone’s Schwarzman used the word “pause” to describe the attitude of Indian industry. He is right. Our own sense is that there is tremendous desire on the part of Indian industry & therefore global investors to begin investment projects in India under a business-friendly Modi regime. They have to wait because their investments tend to be longer term. Stock investors who can flee in an instant are already jumping in as the rally in Indian stocks demonstrates.

Readers know that we have been long term bulls on India’s micro story while utterly negative on India’s macro story of a pathetic government mired in corruption and dynastic plunder. With Modi’s victory, we think the Indian Macro will finally join Indian Micro in a congruent path for sustained success.

That will deliver what global investors like Blackstone’s Schwarzman are waiting for:

  • “We would like the Indians to recover their confidence … and relaunch.”

What If?

That “confidence” is what the markets are smelling. Virtually every one expects a victory of Mr. Modi in the May election. Investors are already positioned for this result. But Indian elections tend to surprise pandits. India is not a presidential contest where people vote for one leader. In the Indian system, people vote for their local candidate and that candidate virtually becomes their “lord” or “Sardar” until the next election. So the Indian election is really a collection of 540 local elections that create the new Parliament which decides on the Prime Minister.

This allows for real horsetrading & negotiations between parties or factions within parties if the election does not produce a dominant winner. That is the biggest risk to the bullish scenario priced into the markets. The reality is that virtually no established leader wants Narendra Modi to win, not even the current leadership of his own BJP party.

Modi is a governance guy and he represents grave danger to the established collection of crony “leaders” who have become obscenely rich via political patronage, a fancy word for corruption. This includes senior government bureaucrats in Delhi and in state capitals.  This coterie has a huge stake in continuing the current system that has so damaged India and impoverished the Indian people. Already there are rumors about BJP leadership in Delhi sabotaging their own party by deliberately selecting loser candidates. Why? To damage the prospects of Modi winning a decisive victory. The current BJP leadership stands as much if not more to lose if Modi becomes the prime minister.

Remember Indian voters, especially those in populous North India, have never experienced a government focused on economic development. They have always voted on local and regional issues. So they have to take the Modi promises virtually on faith and on what they have heard about the conditions in far away Gujarat.

Mr. Modi has to win big in a national wave to overcome these structural impediments and win a decisive victory. The last such runaway election was in 1971 when Indira Gandhi swept away her own party’s leadership to win in a landslide. Her slogan was “remove poverty”. Mr. Modi’s promise is “good governance” for a better life for Indian people. Will he succeed? We will all know in two months.

What if he doesn’t win? What if India gets into a mess of negotiated coalitions like Delhi faced in December 2013 or India faced in the late 1990s? The answer is short term disaster. We hear that successful Indians who can exit India will simply fly out of India with their assets. We hear that stock investors who have piled in will exit immediately. And as one senior trader from the Mumbai arm of a huge Wall Street Investment Bank told us, “the rupee will go to Rs. 75 to the U.S. Dollar”, a 23% collapse.

The above is the classic definition of a binary outcome.

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