India's Golden Conundrum

Indian’s love for gold is spiritual where it is revered as God’s currency. It is only astronomically higher prices which can resist them to buy it. Falling prices are just what India wanted at a time when festival and wedding season is ensuing.

The king of metal Gold is again going south. It touched a 14-month low on September 20, 2014. Such a scenario induces people away from gold to flock into financial instruments. The metal will no longer lure Indians is what analysts believe but India’s thirst for gold will take eternity to be quenched.

Falling gold prices might lead people in other countries to ditch the yellow metal but Indian’s love for gold is spiritual where it is revered as God’s currency and people feel proud of owning it. It is only astronomically higher prices which can resist them to buy it. Gold demand slumped magically when import duty was hiked to 10% in order to control current account deficit. Now that prices are falling, it will be seen as an opportunity to purchase it on low in the hope of price-rise. Long-term return outlook of a common investor in India is always bullish on gold.

Current account deficit (CAD) narrowed sharply to $7.8 billion (1.7 per cent of gross domestic product) in the Apr-Jun quarter of FY 2014-15 from $21.8 billion (4.8 per cent of GDP) in the year ago period. The fall was strongly led by slowdown in gold imports which halved to $7 billion in the April-June quarter from $16.5 billion in the same quarter a year ago. However, the gold imports in the preceding quarter i.e. the Jan-Mar quarter of FY 2013-14 amounted to US$ 5.3 billion. 

To compare the two data, gold imports actually risen on quarterly basis. The reason is because RBI had eased some gold-import restrictions in the month of May which instantly drove the people to invest in gold. This uptick in demand is reflected in the gold import data of Apr-Jun 2014.

It is true that the gold investment at this juncture does not seem viable. Gold futures are trading lower. Improving global economy does not bode well for the metal, to boot. Stronger dollar is also contributing to Gold’s southward journey as gold is used as a hedge against movement in the US dollar, which means its prices will move inversely to change in value of dollar. Indian gold prices move in tandem with global prices depending on rupee’s value against dollar. Since India imports the yellow metal, a weaker rupee cushions a fall in gold price while a stronger local unit makes the metal cheaper. Given improving economic conditions, rupee may not depreciate much against dollar.

That said, why to invest in a declining metal when stock markets are doing well and lower inflation is making returns on savings schemes positive? The answer lies in a trend seen last year. Gold prices had fallen dramatically in Apr-Jun quarter of 2013. Questions were raised if it safe to invest in this yellow metal but coming true to the conscience of Indians, gold hit a record high of Rs.35,074 per 10 grams in August 2013. Hence, it is no hyperbole that Gold is the safest haven amongst all.

With the ensuing festival and wedding season, India’s gold buying binge is likely to be bumper. Low prices at this time are just what India wanted. Irrationally higher import duty had enforced them to stay away from the metal for long but now is the opportunity to buy it on dips. Thus, India’s golden problem is not yet resolved and it is too early to claim that the country’s CAD is normalized. India’s lure for gold can be suppressed but cannot be died in any case. 

Too early to bet big on markets

A reality check of current market conditions sparks good reasons to stay cautious while boarding the bus of current market rally.

Splendid times seem to have unleashed in Indian stock markets. Nifty touched a lifetime high of 8000 on 1 September and Sensex hit 27,225.85, an all-time high on 3 September. Nobody had the foresight to predict such levels for benchmark indices a year ago. But now, our fortune tellers aka technical analysts are certain that the bulls will ride faster and farther from these levels in the days to come.

For Navneet Munot, CIO, SBI Mutual Funds, Sensex hitting 10,000 in 10 years is not unrealistic if India Inc can deliver growth of around 15 per cent per annum, which, according to him, is not an unreasonable expectation over a long period.

However, taking these predictions with a pinch of salt is advisable for retail investors as their hard-earned money is involved. Their predictions might be true but a reality check of current market conditions sparks good reasons to stay cautious while boarding the bus of current market rally.

Needless to say domestic as well as foreign investors are betting on Prime Minister Narendra Modi-led NDA government which has successfully trumpeted its reform-oriented approach in every nook and corner of the world.

Now is the time to analyze whether the positive sentiment lurking around is hope driven or solid result driven. Looking at contracted July IIP data at 0.5% versus the 3.9% of June (revised higher from 3.4%) is enough to warrant that it is too early to stake bets on newly formed government. Though CPI inflation mildly cooled to 7.8 per cent against 7.96 per cent in the previous month but food inflation inched higher to 9.42% versus 9.36% m-o-m.

The week ahead is going to be eventful. First, markets will take stock of IIP and CPI data after opening bells tomorrow with simultaneously eying on WPI data expected to be out at noon. They will be taking note of advance tax payment by listed corporate, which is also due to be released tomorrow and will provide clues about Q2 September corporate earnings.

On Wednesday market mavens will eye crucial US Federal Reserve's monetary policy review. Woe betide the markets if Fed goes for an early rate cut as it will make Indian markets vulnerable to FII outflows leading to correction on Sensex and Nifty.

For investors who do not understand technicality of markets, it is sensible to wait for macro data of following months to come which does not reflect the overhang of UPA government’s tenure so that no confusion is felt whether the slowdown is of UPA’s making or NDA’s failure. Let the time confirm if the Modi-driven seemingly impactful India story is a fact or just the work of a fiction.   

Power Plight

The fruits of privatization must be savored by consumers. If CAG audit of discoms reveals otherwise, the bleak side of privatization will be re-affirmed. 

The power spat in the national capital has been temporarily avoided thanks to Supreme Court. On Friday it ordered Reliance Infrastructure owned BSES firms to pay 50 crores to NTPC, India’s largest power generation utility, within two weeks. NTPC had recently threatened BSES firms to stall power supply had they failed to pay their dues in the stipulated time. Collectively BSES-Rajdhani and BSES-Yamuna owe 300 crores to the NTPC. However, in a reprieve to them, SC has settled the matter at much lower payment till the next hearing due for March 26.

The modus operandi of power sector in Delhi is complex. Amid accusations and cross accusations of corruption and poor governance, it is being hard to identify the malady ailing the power sector. BSES firms assert that the Delhi government is required to pay them subsidy amount so that they can recover their operational costs. They also contend that once government pays them under-recoveries, they will make payments to NTPC. To this Aam Aadmi Party led Delhi goverment hits back stating that the distribution companies are not making losses. They just tamper with their balance sheets to show losses on paper but actually they are incurring profits. The Delhi government has also clarified that the subsidy amount due to discoms from it shall be adjusted against the receivables of government-owned Delhi Transco Ltd, the power transmission company, and the generation utilities, Indraprastha Power Generation Co. Ltd and Pragati Power Corporation Ltd.

Monetary activism

To douse the inflationary fire,the recommendation by the high level RBI committee must be worked upon with urgency and earnestness. 

India’s central bank, the Reserve Bank of India (RBI) is up with yet another concerted effort to combat the notoriously high inflation. A committee headed by RBI Deputy Governor Urjit Patel has recommended pegging monetary management with the Consumer Price Index (CPI) instead of the current practice of the Wholesale Price Index (WPI). Observers believe that the move is commendable since it is the CPI which directly affects the consumers, unlike the WPI. The recommendation, if accepted, will line the RBI in tune with the global central banks which target CPI as a nominal anchor.

However, there are reservations against this proposed step. Food and fuel inflation constitutes more than 50 per cent of the CPI. It is being pointed out that food and fuel price volatility will be difficult to accommodate in the policy decisions once CPI becomes the reference point of monetary policy. This seems a valid point. Nevertheless, instead of taking this into account what causes frequent variations in food and fuel prices in the first place is what one should look at.

Let’s first discuss the food prices. Though weather conditions have a role to play, government policies and supply side bottlenecks are the principle protagonists in the big picture. Without specifying how it would generate enough foodgrain to run, for instance, the Right to Food Security programme, the government chose to go ahead and implement it. Disregarding how it would meet the revved up demand due to increase in rural wages by MNEREGS on the ground, it is still choosing to run it. Also, no justification has been given as to why the Food Corporation of India (FCI) continues to hoard massive quantities of foodgrain, much of it is often left to rot and consumed by rats. Nor is there a grip on opportunist intermediaries either who hoard and block the food chain supply to inflate prices for purely vested interests driven by profit and greed. No legal action seems to follow in these cases of organised horading. Fluctuation in onion prices late last year is the best example of such deliberately manipulated price inflation. 

Coming to fuel prices, no government anywhere in the world can foresee fluctuation in international crude oil prices. The internal mechanism of setting up prices factors in such fluctuations. Unfortunately, India’s internal mechanism itself is faulty. There is no clarity on fuel prices which have been highly subsidized by government. Whether the benefits of subsidy reaches the needy or is enjoyed by the consumerist rich is a chronic debate. The case of subsidising diesel for swanky SUVs etc, is a glaring example.

That said, the food and fuel prices fluctuate due to the non visionary approach of the government. The failing of government should not be imputed as a hurdle on the progressive path of treating CPI inflation as the nominal anchor.

CPI inflation stood at 9.9 per cent in December. If it becomes the nominal anchor, it is feared that interest rates will have to be hiked dramatically to bring it under control. This is not something the government would like to hear at in the current phase since all it wants is to spur growth while an apparent economic slow-down stalks it relentlessly. It is true that the war against inflation is fought on the cost of growth. But, before citing this inflation-growth debate as a criticism, it is important to read the Urjit Patel committee report in-depth. The committee recommends targeting CPI at 4 per cent within the two years with the wiggle room of 2 per cent in either direction. It does not make a case to raise the repo rate in the next monetary policy review.  What the RBI panel is really looking at is to bring CPI inflation down to 8 per cent over the “next 12 months” and to 6 per cent the following year. Going by the Patel committee’s formula, a repo rate hike is therefore not in order at least until early 2015.

India’s Economic Affairs Secretary Arvind Mayaram has called the focus on CPI a “premature step” but there is a strong case for India’s monetary policy to be steered by CPI inflation. It is this inflationary trend which really impacts domestic households and influences their investment decisions. There has been much dispute between a government demanding growth and ‘inflation warrior’ RBI. It is high time to bring a decisive end to it.

Taming inflation is important even at the cost of growth because the virtuous cycle wheeled by a controlled inflation will spontaneously infuse growth in the economy; but the vice versa is not possible. Therefore, the recommendation by the high level RBI committee must be worked upon with urgency and earnestness without losing time.

Divestment Dilemma

Government will have to understand that   

diluting government control on PSUs by stake sales or getting them to divulge their profits as bonus is not the way to fund fiscal deficit.

With another fiscal year coming to an end in three months, the government is staggering hard to achieve its divestment target in public sector undertakings. Divestment in PSUs is important for maintaining the budgeted level of fiscal deficit but given the unfavorable market conditions at present and general elections looming in, a successful divestment program is highly unlikely. That government has 5,000 crore in its kitty with 40,000 crore to garner before the end of FY 14, is of ample proof how serious it has been to achieve this target.

Ideally the purpose behind divestment is to scale up the efficiency of firms by privatization. As per Anshuman Tiwari, the economic analyst and financial editor of Dainik Jagaran, “There is history of debates in India on purpose of PSU divestment. Divestment is the process to infuse efficiency in PSUs via reduction in government control and making them widely held but lately governments have been employing it to raise funds when they fall short of revenues to meet its fiscal deficit target.”