Crystal Gazing 2011 - India

Let's go a bit detail on India. I would focus as much on markets as I intend to do on overall economy. They are distinct in a way that markets tend to become the lead indicator of economic expansion and lagged indicator to a crisis. Call it positive convexity

1. The economy is poised to run full throttle as consumers and businesses race against each other to create demand and enhance supply respectively. The outcome of this race at various stages, will decide the course of inflation. Going by the tradition of conservative capacity expansion by domestic buinesses, I believe, demand would usurp supply for atleast few more years keeping inflationary outlook uncomfortable. The supply constrained economy of ours has been feeding two monsters since long time 1) current account deficit and 2) fiscal deficit, as they help in augmenting domestic supply, one directly and other indirectly. While a robust growth in economy would reduce the relative size of these external sources, there is a risk that they too grow at a same clip or higher. Since the solution to trade gap lies only in building manufacturing and technological capabilities within the country, there is really no solution in the short term. The fiscal situation is also not rosy given that the recent shellacking of ruling party will likely keep them populist and extravagant. So my guess is that both these deficits will remain high, one out of choice other by compulsion. Few enablers that may prevent the deficit problem from spiralling out are 1) fuel price deregulation and 2) tightening of monetary conditions. In absence of global shocks, Indian economy will try to seek its goldilocks condition where there is less of firefighting and policy uncertainty going forward. My view is 2011 is not going to be that year, but 2012 could be.

Broadly my sense is monetary tightening and high commodity prices will prevent the economy from overheating, but we may still clock a 9% growth next year.

2. Its increasingly being feared that the money from emerging markets will find its way to developed markets, as relative attractiveness of those markets increase. This is the new theme which strategists are clinging on to because of its intuitive appeal. I feel enticed to reject it outrightly, but out of modesty, I believe that the reasoning is quite flawed. Equity markets do not have to worry as long as money find its way to some other equity market and not towards USTs. As long as risk appetite is there, emerging markets provide very useful diversification and will continue to see incremental flows. Put it simply - if dow goes up nifty will not go down, it doesn't happen that ways. But at the same time I have no notion of immediate gains in Indian equity market as well. The scam season, tight liquidity, rising rates and rising costs will keep the markets on toes for atleast another 2-3 month. The risk on short side, however, is that all these problems may end all at once or so it may appear. And if earnings keep the pace, market will just reset to factor in even better 2012 earnings.

So my guess is we may see a 500-800 point surge at somepoint during this year, leading to an all time high on Nifty, and therefore every dip for me is a buying opportunity. For bond markets, I believe there is going to be a demand drought for a really long time as banks are invested neck deep even while SLR requirement are being reduced. The bond market is on RBI life support (read OMO) , and may tank once the support is withdrawn.

Happy Investing !!!