panch-tattva talk…inflation paradox

Friends,

 

The inflation number announced today at 11.04% have taken a big toll of market which thudded by over a neat 158 pts and Nifty closed at 4347. Ths level is almost as much as prevailing last year June-july. It was from this point that it had made strides to leap up to over 6300 pts by October 07. I have been harping on the bull tune for last many weeks and have still find it difficult to change stance. I take this occasion to discuss the impact of inflation in reality rather than take it as a damaging factor without recourse to an analysis about its implication. Please note the following therefore:

 

i.  Supposing the index was rightly priced last year june at around tadays level than without doubt the earnings of the intervening year have aded to the book values of shares. If we buy stocks today we are buying the same assets of a company as represented by the share plus the gain of one year by paying the same number of rupees which have lost value by 11% , so in effect this equals buying index (Nifty) at about 3868. It is upto you to decide whether this is a safe level or not while the profit growth on average has been about 12-13% over the year. It is also to be considered that the year ahead would still be posting positive growth not negative growth.

 

2. If we look at choices with the investors we find that net of tax bank deposit will return only 5-6% per year while the inflation stands at 11%. The same would be the case with other avenues of debt instument purchase. If the inflation has really to be kept at bay only the bullion purchase would make sense. It will however not beat inflation. The stocks make you owner of some marketable and productive real assets and give you some dividend yield hence are a better choice. The tax would be attracted on both types of gains ie on capital gains and on dividend income. The direct purchse of real estate is also not OK after its unprecedented rise in recent past. In fact the real estate is loosing value lately.

 

3. If you look at the damaging effect of inflation on earning capacities of existing companies , I don’t find it in any way having such an effect. The matter is simple enough. The inventory of companies appreciate hence would not cause damage. The land and macjinery also would not harm in any way but reversely would have appreciated in value. The employee costs may go up but this costs just about 10% of the cost of manufacturing. Ad quantum taxes would be making the burden reduced to some extent. The end product prices will be raised , may be not by the same percentage but it will still make the top and bottom line healthier in terms of rupees. The companies that have captive raw material source will benefit out-rightly . The banking companies will see default ratio reduced as the burden of paying the principle and interest will be lower in real terms.

 

4. When we examin the demand side of goods and services, it may be said that the expendable surplus income of people will reduce after meeting the essential expenditure which will see lower demand for goods that are not essential in nature. Here I may point out that the savings level of Indians is about 35% and this leaves enough cushion in their hands to not postpone consumption and their incomes will be higher too to leave room for inceased outlay on consumer durables. Also, the inflation would make them go for buying rather than save due to negative net return on saving the rupee.

 

5. It is said by analysts that the RBI will have to raise interest to arrest inflation and this will damage the industrial borrowers. Here again please consider the fact that most of the leading companies have very little of borrowing compared to the size of bisiness operation due to last few years having let them earn huge cash surpluses. On the other hand they would now find the return on capital consideration by the new entrants at higher level and check the entry of competition. The competition will find the capital costs also higher and hence would have to shelve plans. The fund raising capacity of exiting companies will only go up due to revised higher valueation of assets making them more competent to increase capacities through expansion and through green field projects.

 

6.The inflation is considered to be bad because it makes the provision for depreciation not sufficient to replace the ageing plant and mechinery. This is also not valid in light of the fact that the total cash generation is far in excess of such needs of the companies and most of the companies are still distributing a nominal part of their PAT by way of dividends and are retaining larger part of profit for business purposes.

 

7. While we see the high inflation level back in India, we still do not find rupee depreciating that fast viz a viz other major currencies. This only shows that the inflation is prevailent in most of the major economies and hence the parity is maintained. Further the high crude prices get to be benign if there is no more falre up in prices while the inflation keeps it march on. This in a way makes relative cost of oil tend towords the traditional ratio and mitigate the adverse impact of the high oil prices that is felt when  the sudden surge in oil price takes place.

 

8. With inflation the revenue of govt. goes up to and its debt burden gets reduced in real value terms. The revenue expenditure of govt. also goes up but some time leg.

 

9. You may wonder as who is then affected by the inflation. The worst effect of this is on people who are now living on past savings. This section of society also does not have enough say and hence has to suffer silently. In such a scenario they have to sell family silver at certain times to make ends meet. Who then gains if they loose? The gains comes to the active earnign members of society and the share-holders of corporations, so why give stocks thumbs down when it should be the other way round.

 

HariOm,

krsnaKhandelwal