India Wrestles with Inflation

Inflation or Deflation – One Nation two Stories

A random walk down Dalal street and every person you meet says that inflation is easing and high time the RBI cuts rates just walk a little ahead crossing a few by lanes and when you reach the main street, people say it is almost impossible to survive and everything has become so expensive, restaurants have stopped serving extra onions and have cut the dish quantity and cost of other essential things have really increased and the Government and RBI should do something ….

OOOPS

Who should RBI listen to the pundits  and analyst in suit boot or the common man who knows nothing about sophisticated terms like CPI ( Consumer Price Index) or WPI ( Wholesale price index) all he knows is the ground reality enough to make him survive and if possible keep some savings for a rainy day.

Price rise or price fall…. India wrestles with inflation-deflation puzzle.

Baffling figures prompt heated debates between hawks and doves on interest rate strategy.

Anyone studying India’s economy by looking only at its wholesale prices index for the past year could be forgiven for assuming that the country is in the grip of severe deflation, if not economic depression.

In August, the year-on-year change in the country’s WPI fell to minus 4.95 per cent, the lowest for nearly 40 years. The index has been in negative territory for nearly 12 months.

In the same month, however, the consumer prices index showed inflation of 3.66 per cent, and is expected to rise again in the coming months to about 5 per cent. Indians still fret about the price of everything from onions to medical care, and the gap between the WPI and CPI measures stands at more than 8 percentage points.

Disagreements over the significance of India’s puzzling inflation numbers, like those over its reported economic growth rate of 7 per cent a year, are fuelling a sometimes heated debate between monetary doves and hawks over interest rate policy.

Indian business leaders, supported by the government, complain about high real interest rates and the cost of capital. They are pleading with the Reserve Bank of India to slash its policy interest rate from 7.25 per cent, so that the economy grows and people start spending more there by giving boost to India Inc.

RBI (Reserve Bank of India) , on the other hand, is determined to force down India’s traditionally high inflation for the long term and is seeking to meet a CPI-measured inflation target of 6 per cent by January next year, although he is still likely to reduce rates by a further 50 basis points in the months ahead.

On the other hand the government’s feels, that challenge for India appears not to be price inflation but possibly price deflation and a blended measure using components of both the CPI and WPI, suggested annual inflation of 1.7 per cent if calculated for gross domestic product as a whole and just 0.1 per cent for gross value added, excluding the distortionary elements of indirect taxes and subsidies. In a situation like this, to exclusively focus on the CPI makes no sense, contrary to what the respected RBI governor feels.

It is almost impossible to have a perfect inflation index for all concerned in the society but India’s WPI is not a good indicator of future CPI because the two indices measure different things: WPI measures prices of tradable goods, including those of fuel and basic manufactured products such as steel, which have fallen sharply on international markets, while CPI includes services such as health and education.

CPI would nevertheless have fallen further, if India was not burdened by chronic supply-side bottlenecks that government needs to tackle. The government expects CPI inflation to rise, especially after demand is stoked by civil service pay increases to be awarded by the forthcoming Seventh Pay Commission.

The continuing large gap between WPI and CPI is a puzzle: This diverging wedge is not completely understood clearly in a complex economy like India.

While hawks and doves pursue their agendas with the help of their preferred inflation indicators, investors and analysts seem to be leaning towards the notion that India is afflicted neither by the drastic deflation indicated by WPI nor the high inflation usually reflected in the CPI.

There is a lot of anticipation a large rate cut to the tune of 50 basis points by the RBI in its next meeting as India Inc and the government is holding RBI responsible for the lack of growth and they feel that a rate cut would really boost the spending power and people would open their purses. Even if there is a good rate cut by the RBI, what is to be seen is how much of that cut is actually transmitted to the end users by the respective banks.

Let’s take an example if the rates do decrease and the banks transmits a 25 basis points decrease in rate (0.25%), the difference on a home costing INR 150 lacs would be INR 30,000 a year or INR 2,500 a month, on a car of INR 10 Lacs the savings would be INR 2,000 a year or INR 167 a month, in both cases assuming that the loan amount would be 80% of the total value.

Would this be enough to encourage the people to but more homes, cars and spend much more or would such decisions be based on overall macro stability business outlook and growth which looks bleak overall.  With head winds from China , Europe and with the country with weak monsoon which has hurt lacs of farmers , the common man is not going to start spending even with a 50 basis points cut.

To buy a car this festive Diwali season or next would a common man wait for the next year as the interest rates may go down; sure he will save money to an extent in the interest payment as the rates would go down but what about the cost of a car?? Has it historically ever been recused to a large extent? With all the analyst and pundits on Dalal Street talking of a commodity super cycle at its all-time low with metals, crude at all-time lows has the cost of taxi’s or tuk tuk reduced; not really ..

Hence it is important for RBI to pay attention to the Main Street rather than Dalal Street which analyst in suit boots and it could oblige the government and India Inc with a 25 basis point cut to test the waters but it needs to trot carefully.

_ Farzan Ghadially

US Fed Rate hike: Impact on Emerging Markets like India

 US Fed Rate hike: Impact on Emerging Markets like India

The Long awaited decision on when will the US Federal Reserve (Fed) increase the interest rates and how will it affect Emerging economies (EM) like India. The Indian economy is a relatively stable economy compared to the rest of the other comparable EM, however it is not isolated and a change in stance by the Fed would result some foreign institutional investors (FII) drawing out of the Indian market and also resulting in change in the demand supply in the real economy.

Emerging markets braced for ripple effect Fears grow that tightening US policy would damage economies across the globe.

For policymakers in emerging markets, the prospect of the US Federal Reserve raising interest rates for the first time since 2006 has been building like a storm cloud on the horizon for much of the past two years.

Officials at the Fed, however, seem determined to play down any suggestion that their actions might contribute to slower growth in EMs and the rest of the world. Yet if they do raise rates, the impact on already fragile emerging economies threatens to bring economic woes to the US and Europe.

The consequences of a US rate rise, would be appropriate by year-end, would be felt across the world, from China to the likes of India, Brazil and Turkey. The countries that grew used to ultra-loose monetary policy in the US and the cheap financing that it spawned. since the recession. EMs have seen growth soar, partly in response to US interest rates being cut to historic lows, then fall back as the Fed moved to tighten even as Chinese growth slackened. Now, against a backdrop in which developed economies account for less than half of world GDP by some measures, the question is whether the US and other industrialised countries will suffer from the fallout from a further EM slowdown caused by a Fed rate rise.

First we had the spill over phase; this was the inability of the west to generate growth and its use of experimental monetary policies, which have undermined growth in EMs.

Stage two is the spillback; the weakness in EMs that disrupts the economies of the west and makes its challenges even harder.

The most profound consequence of higher US rates will be to accelerate capital outflows from China, the source of recent global market turmoil, making the world’s second economic superpower potentially yet more unstable and to an extent from relatively stable EM’s like India.  

That could create another layer of risk for the Chinese economy, the most important, or the least anticipated, consequence for EM, will be the impact on China.

This is because of a big increase in lending to China by foreign banks over the past six years. The funding costs of such banks are affected by the Fed’s short-term interest rates, which are expected to rise by more than long-term rates. As they rise, this source of capital for Chinese borrowers is likely to be cut.

This, in turn, threatens to feed directly back to the US by contributing to a reduction in Chinese buying of US Treasuries. China had to sell more than $100bn of its holdings of US Treasury debt to support the renminbi during the turbulence that followed Beijing’s decision last month to devalue its currency.

If China, which is the largest foreign investor in US Treasuries with $1.27tn, starts to liquidate its holdings regularly, it could create funding shortfalls for the US government and add upward pressure on US interest rates.

China and other EMs have already had a big negative impact on the US economy by contributing to the sharp fall in oil prices, in turn reducing the flow of petrodollars

THE US currency from the dollar-dominated oil trade that is recycled back to US markets.

By cutting the knees from under a critical contributor to the recovery, China and other EMs have flipped the switch from risk on to risk off.

To many investors, the impact on developed markets of slowing growth in China and other EMs is already clear; falling import prices, lower capital goods orders and much weaker profitability of US and European companies, many of which do a lot of business in EMs.

The biggest direct impact from the Fed outside the US is likely to be in those economies that depend on short-term capital flows to finance current account deficits. Worst off are the commodity exporters such as Brazil, Russia and South Africa as they get caught between the strong dollar and a weak China.

Many emerging economies are less vulnerable to a rise in US rates than they were during the EM crises of the 1980s and 1990s as governments have cut back on so-called original sin. The sin consisted of borrowing in US dollars or other foreign currencies and thus exposing themselves to the risk of a devaluation of their own currencies and a consequent explosion in debt servicing costs.

While that is broadly true of governments in the past decade, there has also been an explosion in foreign currency borrowing by corporations in EMs. Many of these have earnings in foreign currencies, saving them from original sin. But the build-up in such debt among other EM corporate borrowers has generated big currency mismatches. This is not the only problem. Sovereign borrowers have committed less original sin but more new sin.  Even though their debts are in local currency, debt levels have gone up, he adds. Most people believe EMs are structurally sound in terms of debt. That is no longer valid.

The idea that EMs have built up enough forex reserves to cover debt payments is misplaced, as the guys holding the assets and the guys holding the liabilities are not the same. This would mean a vast stock of EM debt coming under pressure as rates rise, even if forex reserves stay put.

  

Real economy woes fuel chronic malaise in emerging markets shrinking harvest how developing nations are suffering. Are emerging markets already mired in a crisis? The question of when to apply this description to the unravelling of EM fortunes is more than academic. The word crisis has a way of fixing perceptions among investors, executives and policymakers while displacing nuance from analysis.

The big difference, between the current bout of EM frailty and the Asian crisis in the late 1990s — the last economic meltdown to originate in the developing world is that this episode has evolved over many months, whereas the Asian crisis was an eruptive shock.

EM has a persistent problem that results from two irreversible shocks. One is the end of an era which saw rapid, investment-led growth in China. And, two, the collapse of global trade growth to levels unseen for a generation,

These twin frailties supply a defining characteristic. The current EM malaise has thus far been driven more by real economy debilities than financial market stresses.

Whereas in the aftermath of the 2008-09 financial crises, the dynamism of EM economies helped drag the world back to growth, the vigour is now all but spent. In the first half of this year, emerging markets became a net detractor to global trade growth for the first time since 2009.

In gross domestic product terms, EM growth is likely to fall to 3.6 per cent this year, its lowest level since 2001 — if the 2008/09 crisis, which originated in the US and was therefore an external shock to EM, is excluded. However, the impact on commodity-exporting EM economies is particularly severe, with average GDP growth falling fast towards zero.

This is not a repeat of the ripples that spread across the world’s financial markets in the late 1990s and into systemic banking failures. This is a crisis of growth.

Part of that crisis, is caused by weaker demand: a reversal of capital flows, falling commodity prices and slowing credit growth. Another part is caused by structural problems on the supply side, such as the misallocation of resources in China, persistent low investment in Brazil and Russia, and excessive regulation in India and Mexico.

There is froth in some markets. Like, Turkey looks vulnerable. There is a worry about South Africa’s current account deficit, but economies will not be wiped out in the way Argentina was in 2001 or Brazil was in 1999. We have not seen that real, sudden pain. This is much more of a slow grind.

The bottom line is that there is no EM crisis for as long as debt defaults do not become a big concern.

But the prospect that the US Federal Reserve may raise interest rates for the first time since 2006 is adding uncertainty to the gloomy EM outlook. the potential for tighter US monetary policy has exacerbated significant EM capital outflows even as EM productivity growth slows.

_ Farzan Ghadially

  

INVESTING FOR THE ULTRA HIGH NET WORTH INDIVIDUAL’s IN INDIA THE FAMILY FUND

INVESTING FOR THE ULTRA HIGH NET WORTH INDIVIDUAL’s IN INDIA

THE FAMILY FUND

With the number of Ultra High Net worth Individuals (UHNI) increasing at a very fast pace in India and with large number of first generation families having wealth over a Billion dollars, the average age of billionaires in India being in their late thirties and forties, such UHNI investors require specialized structures  in order  to make their investments where in a customizes approach and undivided attention from the fund manager with enormous flexibility to meet the need for every such UHNI/ family. Hence most of the services provided by banks under the private banking domain may not help the UHNI clients to a great extent and they require a more customised and specific approach to manage their wealth and investments.

Wealthy investors have been investing in collective investment schemes like Alternative investment funds (AIF), Mutual funds and other schemes for many years.

Often they are seed investors whose investment provides a fund manager with sufficient mass to launch a fund as there has to be a minimum contribution by the sponsors in case of AIF the minimum contribution by the sponsor needs to be anywhere between 2.5 to 5% with a minimum amount of INR five crores to ten crores respectively depending on the kind of fund launched.

The turmoil in the financial markets in the last few years has presented unprecedented challenges to the collective investment scheme vehicles that have been used and therefore to the wealth investors as equity holders in these schemes.

Investors suffered huge losses valuations were suspended and redemptions were suspended or limited via impositions of gates. Gates being a provision that limits redemption to a certain value or percentage of an investors holding. Most of the investors were not paid in time. UHNI’s realized that their level of wealth or relationship with the fund managers did not itself give them any preferential treatment and they could be paid in priority. UHNI’s were left discussed by the limited amount of information  they received about the investments made and a lot of questions arose on the kind of selection of the companies and instruments were the investments were made. In spite of the being a large part of the investment fund they had limited influence over the service providers. There by setting up their own family fund.

Hence there has been an increased interest amount UHNI to look at a collective investment scheme or setup that focuses on their interest and where the fund manager gives preferential treatment and customized investment solutions keeping in mind the requirement of the specific UHNI.

Hence it is advisable for UHNI to setup their own investment vehicles some of the important reasons why UHNI should setup their own investment vehicles are as follows:

·      Insolation from other investors :

 With the insolation from other investors the setup can be structured exactly how they wish in a much customised format keeping the requirement of that specific family in place in terms of business obligations, family cash flow requirements and expenditures. This would help the UNHNI choose the investment manager , decide the fees depending on the quantum of amount investment and time period for which the amount is given, sectorial preference or any resections required by the client can be clearly specified. Furthermore as far as the outside world is concerned, while the clients affairs are ring fended in a separate fund/vehicle, the clients as investors have the flexibility in decision making on the investment front as well.

·      Confidentially :

The fund would make the investment not the UHNI who is the client as the investment can be made from a holding company which could be in a jurisdiction suitable to the client depending on a number of factors. The use of a separate legal entity to invest may provide additional confidentially, reduce liability and if the fund is regulated it can add a level of sophistication that may speed up the underlying investment process by virtue of a streamlined due diligence

·      Pooling of family wealth :

Pooling of assets / pooling of wealth can result in economies of scale in terms of investment due diligence and operations as the same amount of talent can take care of a number of UHNI’s at a very small incremental cost and all aspects like tax planning and payments, legal advice in terms of structuring and litigation if any all such services when pooled gives that additional purchasing power there by availing such services from industry experts at a much better price point there by resulting in an overall lower investment cost there by resulting in better return on capital employed. Investors can also be given exposure to a diversified portfolio without having to replicate each separate investment themselves. If the fund has ten investments then an investment in the fund gives indirect exposure to the performance of the ten investments.

Investments are bought and sold via a single entity rather than each family member separately. By using a family fund vehicle, a particular member of the   family can be given the responsibility of managing the assets of the other family members. This can be objective particular with families that have adopted one of the forms of Sharia law (where the eldest son is to manage the family assets of his mother and siblings) but can also be used when family members wish to entrust another family member with the assets.

This is works very well in the Indian conditions where in a family is made up of large number of people and each one of them require these services separately as they have their own wealth and requirements which is separate from the combined family wealth. 

·      Distance family members from the assets :

A patriarch or matriarch can enable family members to benefit from economic success of the family but be isolated from the underlying assets. The family members own an interest in the fund not the particular asset. The underlying asset will be freed from the issue that can affect individual family members such as death, divorce and incapacity. If a family trust is used the family members will benefit as beneficiaries of the trust and not as investors in a family fund vehicle. In additional some investors can participate in the fund without having any managerial responsibilities, such as by use of non-voting shares or limited partnership interests. Family members should be given a certain responsibility for the part of family’s wealth so that they feel enfranchised and take responsibility for their own actions. It is also recognized that certain assets are difficult to pool, such as particular works of art, antiques, vintage care etc... With ties to certain family members and properties used by some but not all the family members.

·      Flexibility :

The operations of a fund can be simple or complex as per the requirements of the specific UHNI family. But it is extremely important to have proper documentation Many patriarchs and matriarchs believe that all the family members get along and want what they want which is seldom the case and it is important to have a plan in place should anything happen to the head of the family there arises a lot of issues and complications and is often seen as a major trigger point where in the whole family equilibrium is disturbed and may result in a legal litigation.

When the family fund is put in place at a bare minimum the fund should consider the following:

1.    How will new investors be admitted, if at all? Frequently, investors will want to invest in specie by contributing already held assets. Considerations should be given to transfers by existing investors in whole or part. Regulatory considerations would be necessary if, for example, there is any form of offer or solicitation to invest.

2.    How will the investors be able to exit?

Redemption by the investors, repurchase by the fund and transfers to third parties will need to be considered. Typically these funds are a very private affair but it is essential there are ways to return value to an investor. For example the family members may have creditors (including a divorcing spouse) who need to be paid or the family members or different braches of the family that want to be separated. What begins as co-investment by two siblings initially may result in multiple co-investments by cousins in a generation or so with very different family dynamics. However an exit does not have to result in the sale of the underlying asset, if for example one family member can purchase the interest of another. The most common mechanism to deal with these issues is a combinations of transfer restrictions, pre- emption rights, put options, call options, and drag and tag provisions.

3.    Valuation :

This is essential in respect to the two points above but also in respect of any fees being paid to the fund manager or other service provider. Certain assets are pretty hard to value mainly alternate assets like art, wine and collectables.

4.    Decision making :

Determining which family member will be given which role and whether any external decision makers will be engaged is a key part of the structuring process.

Owing to the growth of the financial markets and complexity of these markets it is extremely important for UHNI families to grow or even conserve capital depending on the time of the economy, there by the need for heights quality of professional advice is extremely important. With the evaluation of culture and values in India most families are together yet separate in many terms as far as business and wealth is concerned hence a family fund approach would be one of the best possible options keeping in mind their unique requirements, flexibility and economies of scale for employment of the right kind of talent.

_Farzan Ghadially