Indian Economic Winter 2.0 - The Final Innings

Indian Economic Winter 2.0 - The Final Innings

  • 20 Feb 2016

Indian Economic Winter


20 Feb 2016

Opening Note :-

After much promise I have managed to push myself to publish this note. It was due in Oct of this year but as stocks rallied I waited out till Dec, then we updated all the economic data points to make them current and the problem with India's corporate sector was clear. It should have been published before the Jan crash in the markets but that does not change the facts. In fact the recent events have only reinforced the economic outlook, that the Indian economy has entered it's own economic winter. In fact this story is easier to sell today than it was when I originally conceived it in 2010. Within six months of the 2010 report all stocks high on debt topped out and have been falling for the last 5 years. So the view was proven right in that respect. In the light of the theory India took it's economic pain. But as the data points show, we have not done so completely. The stock market was quick to recognise the coming crisis and funds reallocated capital to defensive consumption and export driven sectors as the currency declined. The economy remained inflated due to negative real interest rates. And that simply drove the market higher hoping that Modi would solve it all. The Nifty hit 9116 without addressing the debts that the corporates had left the banks holding behind. In the last quarter the RBI diktat to banks to come clean, finally, has pushed the process forward. This makes me confident that we are now in the final phase of India's Economic Winter - 2.0, the second coming. The second coming is pushing the financial system to the brink and testing it's limits. I know the RBI has stated publicly to not be scared and that this is normal and not all debts are bad. He may be correct in today's context. But that is not how an economic winter works. There are risks to this strategy because of the cascading effect of winding down of debts that were built over 70 years. You are asking all the participants in business and finance to change the way an entire generation has been functioning. To own up to their debts and pay or there will be consequences. Doing so at a time when the economy is slowing not just locally but globally has a multiplier effect. And add to it the risk of a global deflation. I do not think it is over and ends this easily. This is a generational event and the impact will be far larger than anything I or anyone alive has seen. And because India was under the British Raj, financial history of a previous Kondratieff cycle within India is not available for reference. You have to study the previous cycle from Global financial history to understand what lies ahead for India. The RBI was formed in 1935 from where India's current economic cycle starts from the depths of the great depression. So let me explore all of this to come up with a clear outlook of what to expect going forward from here. 

INDIA'S KONDRATIEFF CYCLE : by Rohit Srivastava PART 2.0


And its impact on the Indian Stock markets and Asset markets. The 70+ year financial cycle surrounding business cycles.

PART ONE 25 FEB 2010-2012 KF Cycle : Update in March 2013   Cycle Update 

Winter Update and follow up Articles on Economic news 2014-2015: Winter Updates

The Kondratieff [Kf] cycle or waves are the brainchild of Nikolai Dmyitriyevich Kondratyev. Ian Gordon provides the most comprehensive explanation for the US markets and his writings are found at and his charts at To simply read the background on the theory visit 


India’s Kondratieff Cycle – Myth and Reality

Every Technician at some point in his career has been intrigued by the KF cycle because it studies economic data like a technical analyst does on a chart and depicts cycles. Cycles carry the power to forecast the future if measured correctly. However the detractors have been put off by those using the cycle to predict an immediate market Crash. The use of the knowledge of the cycle to identify the next crisis gives it a bad name but that is not it’s only use. 

So we must understand the following.

1. It is not a time cycle but a cycle of events that take place over the life cycle of a generation and therefore it is a generational cycle whose length is directly related to the life expectancy.

2. It lays out economic measures for the cycle and tells you where you are. The end results are known but not how we will get there. Government policy needs to be followed for this as well to understand the near term trends.

3. It relates to inflation and deflation – but those are the results of monetary action. So it actually relates to studying all monetary indicators like interest rates currencies debt/gdp etc at a Macro level to get the full picture

The cycle can be summed up very simply understanding its Four Seasons

1. Spring – the birth of an economy, start of economic activity [20-30 years]

2. Summer – the end of the first growth phase followed by subsequent inflation [10 years], recession from the contraction associated with controlling inflation and monetary excess

3. Autumn – High Growth amidst low interest rates and inflation, leading up to a bubble in asset prices, and build up of excessive debt [10-20 years]

4. Winter – the process of closing out the debt so that the economy can grow again at a rate higher than the cost of capital. [10-20 years]

The last part [winter] gets the most interesting because it is the only one that involves excessive pain and someone is going to be blamed for it. Though the debt is built up over several decades human memory is short. So those in power do not want to take blame for pressing the reset button. This leads to decisions in the short term that postpone the eventuality, or to solve it without too much distress. While the end result is that the Debt must come down as a % of GDP so that the cost of capital is lower than growth, there are many paths to this end.

The government is forced to get involved [because it affects everyone] and therefore the path cannot be predicted. You may get outright deflation, or maybe hyperinflation first, or maybe a middle path with negative real interest rates for years, with mild inflation. You may see a lot of defaults or a lot of bailouts. You may see massive transfer of assets from the private sector to the public sector, or vice versa. How the debts will be cleaned and who will be made to pay for it? In one way or the other the public at large pays. Through inflation or taxes, by government bailouts [tax payer money], or bank runs on public funds. It can be done in 2 years or take over a decade. 

For this reason the detractors will tell you not to follow the Kondratieff cycle.

However that misses the point. When we know that we are in a period where debt is the problem and we know that we are going to pay the price for it, there are things we can do. For example we can avoid investing in Debt laden companies. In that sense my Forecast for a Indian Winter in Feb 2010 was the most timely as it came 6 months before stocks with high debt would lose 50-90% of their value over the next 5 years. And so they did.

In 2009 I said that to a Mutual fund head, do not buy debt laden companies but low debt companies with cash flow. He told me that it is not the way to manage a portfolio. So you get it. Most people will ignore the knowledge of financial cycles and put you to risk. But you should be aware of it.

I wrote the first Article on India’s Economic Winter in Feb 2010 and it is only after 2013 that we have started to recognize that India has a problem in debt. Only after 2014 are we seeing a clear trend in rising NPAs at PSU banks, which were not being reported earlier. Now it is common knowledge that over 200,000 crore of funding is needed to replenish the balance sheets of banks. This year 20,000 crore was announced by the Finance Ministry. We have a Long way to go.

The good news is that we have now recognized the problem and therefore started to do something about it. Having done so, we are now on the path towards ending the winter cycle and Kicking off into the Kondratieff Spring. My timeline for the Start of Spring is Jan 2017. So the Winter should be done before that. I can however be wrong on time depending on what the government decides to do.

My biggest fear at the time of the Modi election was that we were going to be pushed into hyperinflation. The markets optimism with his solving our economic problems was disturbing because with debts this high inflation is the only result that the markets can celebrate. Without more inflation there was nothing in it for the stock market.

However Inflation is the legacy of the previous government. If you study the 1998-2004 period that BJP was in power, the path they took was one of consolidation. Reforms were implemented but the government balance sheet was also repaired. State debts were restructured and the stage was set for what they called ‘India Shining’. So why did they lose the election?

My socionomic answer to this is simple. The lack of speed. We often believe that the people at large want economic growth. But they do not. People at large have basic needs and are not concerned with Macroeconomics. So the primary reason for the loss in the 2004 elections may have been that the slow process of bringing about the change needed to kick off the next cycle of growth took so long that by the time growth had taken off the effects had still to be felt at the bottom of the economy by the public at large. Before the election the Sensex had doubled in value but we were just first year into a bull market. Social mood had not changed to Positive from Negative.

Therefore the recipe often cited by in the media by Uday Kotak that should go for the Marathon, well it won’t win the next election. It is going to be about speed. The people In India are getting impatient. 2008-2015 has been a long period of slow growth. Especially inflation adjusted growth. The inflation [CPI] adjusted Sensex is still below the 2008 highs as shown below. If the effects of the policies of the new government are not widely felt by the next election then I wonder if it would again result in a change of guard at the centre.


Till Oct I was not sure how speed will show up except if the world markets crashed. Our own process of adding up NPAs was going very slow. But now that the RBI has its guns out speed is here. Someone in power heard my voice, or had a voice of their own, saying the same thing. 

 Social Mood needs to be positive for the existing government to be voted back in power. Since we are in the midst of an economic winter, the quick thing to do is take the bitter pills needed on the Debt’s that the Indian Private sector has taken, and help clean up the act quickly so that we can kick start the economy fast. The debt problems are not going to go away. And since the government does not have the public mandate for Inflation, Inflating the debt away by money printing will also be a recipe to lose elections. What I am not sure about though while making this prophecy is whether the public in general understands economics. They will only react to the pain in between. The current path while good and the only quick way to get back to growth, will inject pain on everyone in India in the short term and the social impact of that is not known. What will be needed a year from today is quick action to revive the economy from its depths as well to get full marks for the work done. All this so that before the next Parliament elections we are well on our way into our Economic Spring.

Whatever must be done therefore should be quick. The US did just that between 1929-1932. Most will tell you that the US stock market crashed 90%. But the good news is that they allowed it to happen in 2 years after which the market went up all they way from 1932 to 1972 [see chart below]. That was the US Spring. Note the first wave from 1932-1937 was 5 waves up and saw the Dow go from 40 to 195 almost 5 times up, this even as it was not yet at the all time high. This was a huge and quick recovery because the US after writing off bad loans could stimulate its economy in the midst of favourable demographics, and strong technological innovation. But the economy slowed by the late 60’s so 1970-1982 maybe considered the Summer. This period saw 20% interest rates to curb inflation that was also in double digits.

The subsequent Autumn bull market went on for 25 years. Though the usual length of Autumn is 10-15 years. This is the longest Economic Autumn bull market in history. 2007 onwards the US is in a winter dealing with its debts.


So how does India look? Lots of similarities! The Indian Economic Spring started in 1935, that is when the RBI was created, in case you do not know. So it was the start of monetary economics in India. The bull market up to 1994 was the Spring. After that India faced both double digit inflation and interest rates in excess of 20% for many corporations with a lower than ‘’A’’ credit rating. I call this the Summer up to 2001. Many coalition governments and a Tech bubble in between were followed by the completion of a 7 year contraction in the economy. Managing finances of the government and keeping inflation under control were primary goals of the period.


The Autumn started in 2001. 2002 was the point where it appears that you finally had the inflation beast under control and interest rates were aggressively dropped. As inflation was now subdued and by 2002 interest rates [floating rates] reached a low of 7%, it kicked off our most recent growth phase. The Autumn always ends in excessive debt and asset bubbles. Now while most have started to recognize the debt part few will acknowledge the ‘’Asset Bubbles’’ in our economy. India’s Autumn ended for debt laden stocks in 2010 itself but for the stock market we maybe at the same point the US was in 2007 TODAY. In the Chart above which I published in my first article, and this chart is courtesy Vivek Patil who has backdated and published the Indian index data based on the RBI Index. Vivek needs no introduction for his Neo wave analysis that is widely read. At that time I wrote that the winter would end by 2013 but when the market bottomed and took off after Sep 2013 I was not convinced that the winter was over because the Indian financial sector was still sick and nothing had been done about it. So the timeline is now for it to end by the end of 2016. 



Did I say 2007! All over again…? This time it is India. You might find that startling or even stupid. But what happened after 2007 in the US was that the debts had to be paid. The way out was bailout the banks. Citibank survived but it’s balance sheet was diluted by the funds that had to be infused into it to survive. In the recent months Indian debts are coming due in larger numbers. The game is coming to an end as banks find it increasingly difficult to hide the restructured loans and risky debt that has still not been marked as NPA. The RBI is making louder noises with banks, to come out in the open and solve their problems.

20151209 174924

New rules of the game are being put in place. The final touch to this tune will be the new bankruptcy code. However there is something that should be understood about the code. This is my opinion. The code attempts to identify problems in debt early and resolve it by attaching assets quickly enough so that the right value can be encashed out of it. The idea is to not allow the corporate from cash cowing its assets to the point that the firm is eventually worthless. It is my feeling that this new law is perfect and will aid the next Economic cycle in extending itself smoothly, however it might do little at this stage to solve the problems of the banking sector. We are not in the early stages of the debt supercycle. Banks have been hiding their NPAs under the carpet for long enough without proper resolution that this new law is meaningless to start with for the current situation. The way ahead here is going to be none other than what we witnessed in the US in 2007-08. Once the size of the problem comes to the surface the banking sector will have to be saved by outright bailouts from Taxpayer money, that is the government or a Consortium of private parties or Foreign investors who will lap up the stakes to help Recapitalise the Indian banking sector. Some corporations might be allowed to fail as well. All of this may happen in a short period of time when it does and will be the painful medicine that our economy will have to take to get back on track.


There is no Alternative in my vision. You may offer me government spending to boost the economy enough to make these business loans viable again. Spending of that stature would be inflationary all over again or even hyperinflationary. It is hard for me to judge that the RBI or current government is willing to push the Inflation button. For it to do so they will need the public at large to be in consent. It could mean risking the next election win, if you expect the public at large to understand. For this reason I have always doubted that the new regime would attempt inflation again. The first attempt after 2008 by the former government has already fallen on its face. So a repeat appears mostly unlikely. Around the world we have seen governments create Fear in the minds of people to accept their decisions. Greece is the most recent example where people lost access to their cash and then accepted Austerity without a protest. But that might not work here at this moment because India is still not facing a crisis in headline numbers. In the words of those in Power, India is growing at the highest rates in the Emerging world or even developed world. Try telling the Indian public that 200% inflation is good for you. But then again let me not conclude here, the right thing to do is keep an eye on government policy and you will get a clue. So far nothing indicates that we are going to Print our way out of this and so it is going to be Bailouts and recapitalsation of debts and that is in short the definition of ‘’Deflation’’, as seen in an economic winter.

 2015-11-08 09.23.56

So get the picture RBI has pushed the banks over to complete the debt write off's and restructuring by 2017. It also claims there will be no major pain and the situation is manageable. The problem is not that simple. See we have just re-jigged how we calculate GDP by including indirect taxes as part of the calculation. This at a time when Service tax rates are being jacked up every year. The calculation just does not match the underlying numbers of manufacturing and IIP growth. My sense is that the new method essentially inflates the numbers by using value addition as an excuse. Just because something is a global practice does not make it a good practice. Do we want to go the China way by making all our numbers suspect. Remember what we did with CPI when UNME numbers were too high to handle. A new series was introduced. I am not against a more logical measure but attacking numbers and not the problem is a problem in itself. So we are in an economy that is slowing down, and world GDP forecasts for next year are also being cut. I fact increasingly the IMF and others are calling on the Government to play a greater role in world growth over and above leaving it to central banks. The Central banks have done all they can and the Government needs to implement structural reforms and maybe resort to Fiscal stimulus is the message being sent out to the developed world. Most have taken the QE path as existing debts are already so high that weakening the Fiscal position is considered risky, due to the unknown impact it can have on the bond market. For countries like India the problem is even more peculiar.

But the point is that the world is headed for slower growth. In this environment when we start restructuring our Banking sector there is going to be a cascading effect on the economy. For every failed business that is going to be pushed into declaring bankruptcy there is going to be some unemployment and an overall effect of slowing down the economy further. That slowing down also has an effect on existing business that are not in financial trouble, but are forced to cut back on costs and business plans to adjust to the slowing down of the economy. This has a multiplier effect. There are also social effects that means that society wide the mood turns negative. So you will also have to deal with the potential side effects of negative social mood. 

20160220 124618

See the article in today's papers today and let me put it in perspective. The good news in this article is that banks will not fail because the government has their back. Yes and that means a bailout for them all eventually. But the losses are real and have to be made up for from the Union Budget. So there will be little left over for public spending driven growth. Defaulters to be put behind bars now? Do we have that many jails I wonder. Because this overlooks the cascading effect on loans outside just the corporate sector. The impact of this slowing of the economy on household debts and defaults in housing and other loans etc. I know that the Indian household sector is considered the least levered. But real estate and infrastructure are not. Most of the Banking sector collateral is in the form of Land and Building. Is all this possible? Let me now say any more without some charts.  

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The Kondratieff Indicators 

With that let me get into the actual Measures and charts. Debt is the primary indicator that tells us we are now deep in Winter. Many economists will not acknowledge that India has a problem of debt but I am going to show you that it is now way out of control. The reason we do not acknowledge is that there are other nations with higher levels of debt today, but that is no reason to celebrate. 


My total Debt to GDP, green line adds up not just the government debt and bank credit but also external debt and assumes other debt from NBFCs FDs etc at a meagre 8-10% of GDP. So our number is clearly higher than 143% but closer to 152% [Green line]. Yes this number is small but so was the case of the United States in 1929. If you study history there was no reason for a US collapse in 1929, The Debt/GDP was a meagre 135%, so what happened. It was a globalised world where Europe was the epicentre and Britain had colonised the world. But like today debts had piled up and the deleraging process started. The high impact on the US had partly to do with their own decision to write off bad loans, by allowing corporates that had made bad investments to ''FAIL''. Understand this, read it again, and then you will see the parallel to India today. They decided to allow bankruptcies to take place and expedite the process of getting rid of bad loans. The action in the midst of a deleveraging world was banking failures and closure. The economy and stock market collapsed. A 90% fall in the Dow followed from the high to low. The good news? It was over with in 2 years in terms of the stock market. The FED stepped in late but eventually put in money for the banks. The government stepped in and spent money to get growth back. The fall in GDP initially pushed up their Debt ratio to 260% but it fell from there for decades to come eventually. So here we are in India at 150% with a slowing and deleveraging world economy pushing our banks to acknowledge failure....Should I expect a different outcome? I do not think so. By that I do not mean that the market falls 90% but it will fall hard taking down even the best performers with it for a while. But be aware that the recent move by the RBI has put us on a fast track equivalent to the one faced by the US during the Great depression.

The next thing about the chart above is the divergence in the ratios for the government and others. The Government debt ratio [Pink line] hit a high of 82% [90% on old data], in 2003 and has been falling ever since. It is at 63% plus 3% for external debt of government. In fact external debt was also at 16.28% in 1992, so at 3% there is nothing much to worry. However external debt of the nation is at 25% of GDP, so the bulk is now owed by the private sector [ECB+FCCB+Other] The non government domestic debt which is mostly bank credit however has also been rising ever since. What has happened therefore is that once the 2003 bull market took off the government started to deleverage its balance sheet. Exactly as you should. Stimulate during a crisis and balance during a boom. In the interim however the private sector has taken on the debt load not just in the growth years but also in the years afterwards. This is the primary reason that they are screaming for lower rates for all these years. They have continued to borrow to pay back old loans and stay afloat and hopes have been high that interest rates will decline and save them. So far that has not happened except marginally. Even after the 2008 crisis once the government stimulus eased off private debt continued to expand. Also they have increasingly used external debt to lower the cost of borrowing which is now fraught with foreign currency risk. 

But this expansion in corporate debt it seems is not a domestic phenomena. Post 2008 corporate debt has expanded almost everywhere, but particularly in the EMs. Charts courtesy this article




 The number doing the ciccles is around 9 Trillion dollars of new debt added after the Great Financial crisis by EMs alone. Which is why falling EM currencies last year have pushed countries like Brazil and Russia to the Brink. China has most of its debt domestic and so that is a different story. But what about India? We faced the headwind in 2013, and have been safe since because RBI stepped in with foreign money. Borrowed from NRIs, and allowing fresh flows into Indian debt markets by raising limits time and again. But has this made us safe? In a crisis when Foreign investors are forced to sell Indian stocks [irrespective of the perceived strength or our economy], the resulting damage to the currency will have a contagious effect on our debt markets that have been expanded further with the help of foreign money. We saw the curtain raiser in January, if we believe the news that Sovereign wealth funds were forced to sell their India assets to meet their financial needs. This has nothing to do with our fundamentals but has punished our markets and the currency both.


In the interim as these debts turn due the NPA cycle has turned across the EM [Chart from BCA Research] space with rising numbers and so has been the case in India. [Chart below from the Economic times]


This years number is going to be much bigger as a lot of the loans are being marked as NPA, Now the biggest threat to a debt problem for any nation is that of interest rates and if you noticed the most recent rate cut did not have an effect of lowering the rate in the bond market for long. So the pressure has started to build up.


The Power Finance companies some time back had to also write off losses as the efforts to clean up started. The government is already on  the path to deflating the excess from the past so there should be no doubt that India is already in the Midst of its own economic winter and missing piece to the puzzle remains asset price bubbles that are still to deflate along with it. Overvalued stocks and real estate need to correct. Till that happens the big question on everyone’s mind in that respect should be ‘Will they inflate’. That has been the only question I ask when the new government speaks about the economy. The run up to the 8000 mark last year was a great bet on inflation coming back. But in hindsight you will see that it was the effect of past inflation. The previous government inflated at will, and RBI held back rates punishing savers. Negative real rates pushed people into gold and real estate. The impact of previous expansionary measures, OMOs along with the stimulus were the real drivers of the market pushing up consumption driven defensive stocks and exporters that benefitted from the weaker rupee. 

However all these measures that show an inflated GDP are not resulting in growth and higher earnings. The great divergence between reported growth and actual earnings is now loud and clear that the current strategy is not working and thus the markets are far too overvalued. Chart courtesy Capital Mind. 

So after 3 quarters of negative growth historical market valuations remain elevated with the growth the valuation gap at the most in years. Hope was that growth will rebound in the second half of the year [based on media interviews], I never understood how. And so far there is not a whiff of smell of growth anywhere. So inevitably valuations need to correct. Recently even 2017 forecasts are being downgraded.

As a believer in cycles I am not a believer that the actions of the government are detrimental or not in the right direction. In fact the institution of Bankruptcy law and announce infusion of funds into state run banks are the end game. They see the problems and are working to the right ends. However it is for us to understand that this does not come without hiccups. Fund infusion into PSU banks is estimated at 2-3 lakh crore rupees total and that cannot come without diluting the size of the balance sheet of these banks one way or the other. And that means that their stock prices cannot be where they are today even after the recent crash. Unless we know the prices at which the equity will be expanded. So uncertainty plays till a clear timeline for the investment is announced. The sooner they do that the sooner the market can stabilise for this sector. 

So an economic slowdown is imminent. The big question is will they inflate or consider fiscal spending, against a mandate to fight inflation. If you have not noticed the money growth reported by RBI had dropped to single digits. So the RBI had moved to a tightening cycle as well, market interest rates are losing their meaning. That reverse policies have the reverse effect should be noted by all following the economy. That has resulted in slower credit growth, low IIP, dropping GDP growth rates, and now a complete collapse in exports. In a competitive world the positive rub off of currency devaluations can quickly be exhausted as other countries take equivalent measures. So everything ends up being only short term. A zero sum game. So it should come as no surprise that our trade is contracting, the exact opposite of what is mandated. 

The real revival of the economy is now dependant on convincing the people that more inflation is good for them, or coming up with technological advancements that will boost productivity based growth. While we speak about our demographic dividend, at the end their behaviour from one generation to the next also encompasses a cycle. It is not only about demographics but how one generation behaves with respect to his or her finances. 

The 90’s generation retired and as the excess from the previous cycle consolidated, a new generation that joined the workforce into the 2000’s became the cause effect for buying new houses and cars and going on holidays. As this population ages its spending pattern also changes, to saving for retirement and better standards of living. The overcapacity that builds around one generation takes time to rebalance itself while the next one is joining the workforce and getting ready to spend again. This is what causes a slowdown and recession in the economy. 

Growth is therefore a behavioural outcome. It has to do with the mood and behaviour of the population at large and the demographic profile. On the outside this is either assisted by or held back by the financial cycles. When financial excess is low and expansionary cycle is helped by finance, and when there is excess [high leverage and debt], then it can harm or slowdown the behavioural cycle. The interaction of these forces results in higher or lower stock prices. 

Where we stand today is at the end of a cycle of financial excess. This is showing up in growing NPAs and defaults. The generation that drove the consumption boom from 2001 onwards is now in the middle ages and a new generation is entering the workforce. This rebalancing will result in a new wave of demand going forward and in the meantime the financial system needs to reset its excess from the previous cycle so that it is prepared to take on the new one. This can cause pain in the interim. Taking the bitter pill is the best option for the long term.

Blowing bubbles without correcting the past will only lead to the blowing of new and bigger bubbles. In that respect there are lessons to be learnt from the mistakes of the western world. However like I said at the start I am amazed that we follow the same financial model as the rest of the world and are going to face the same problems but are unwilling to accept that we have a problem to start with. We are if you ask me where the US was in 2006-07, or more so in 1929, with respect to the financial cycle. What we do as this unfolds over the next 12 months will determine how it ends, and how soon we can get on with the next Kondratieff Spring bull market.

I have set my watch to October 2016 for the worst to be behind us. Those expecting the government to go out of the way and take rash inflationary measures without addressing the problems first are only hoping for more bubbles and not genuine growth. For once let us do this correctly. The current regime so far shows the resolve to do so. That is probably the RBI has also moved ahead with a quick act to clean up the system. It took guts to do it. In the interim let us take the bitter pill. 

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The Game Changers

The two biggest factors that hurt debt the most are inflation and interest rates, and indirectly currencies. So let me review the situation here.


This chart from Capital Mind give you an insight into what we are likely to face. Over the next few years the government faces the task of rolling over a lot of its debt which can be a pressure point for the bond markets. So far since 2013 our bond markets have been managed by attracting global investors into it on a bond spread. As rates are cut locally, spreads narrow and the currency pressure combined, put upward pressure on market based bond yields. This leaves the RBI to do a lot of Open Market Management if it intends to keep rates low.


Your view of interest rates depends on which chart you are looking at. The long term chart above gives you a picture of lower and lower rates. They peaked in 1992. The SBI advance rate or prime lending rate is no more relevant today but the bank rate reflects the general long term direction. But the real question is whether interest rates are going lower today or this year or not and that needs a closer look. So this chart of the 10 year GSec gives you the picture.


My long standing view on this has been that the 10 year G sec rate has not topped out. From the low in 2008 we are in wave C. Wave C typically has 5 waves. So far 3 waves are up and wave (e) of C is pending. If the yield fell below the point marked as (b) then we would have to think that the rate cycle might have changed. But holding above it the trend is of higher tops and bottoms and leaves open one last and final spike in yields in interest rates. The upper channel trendline is at 10.27% so as long as we do not see a decline below 7.089% on the 10 year GSec the view is that we will see 10.27% or higher first. That should be the last push up before interest rates top out and start a major decline phase. I believe it will also mark the start of India's Economic Spring, the next major long term bull market that could go on for 20-30 years.


But how do we know that this bear market ended? While technically we can project to the previous bottom made by an index, and come up with some really bearish numbers. That does not account for the potential for inflation in between. If at some stage in between this process of deflation the RBI/Govt. step in to inflate the economy? You may measure the bear market with a ratio for a better call on it like the Sensex/CPI ratio above or the Sensex/Gold ratio. The Sensex/CPI ratio is still below the high of 2008, and can go back to test the 2009 low in a bear market. Note the ratio going back there does not mean the Sensex has to go there, because there is inflation in between. Similarly the Sensex/Gold ratio chart is above. This chart uses Gold prices in $ and multiplies it with USDINR, in other words the Gold rate is in ounces. I did this because of more price history is available for the comex price. In this case too the Sensex peaked in 2008 and has not made a new high. In fact the ratio has started to fall recently given that Gold prices have broken out on the upside. It is my sense that Gold is going to keep outperforming equities till the end of this deflationary cycle. The ratio above could fall to 0.103 if C=A, or lower based on the Head and Shoulders pattern on the chart above. Note how many times the neckline at 0.1736 held as support again and again since 1993, 4 times, including at the 2013 market bottom. However I think that level will break before the Economic Winter is over. 

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So what will be the impact of all this on Real Estate?

Up front let me add that I am not an expert on this. In fact I am told that if Gold goes up so does Real Estate. On the other hand higher interest rates make Real Estate risky in the near term. So maybe the two will deviate for a while and then there will be a bit catch up. I am not sure. But a deflation without any impact on Real estate is hard to imagine. This chart again from Capital Mind Puts Realty into focus. While most of the little credit growth should have moved to manufacturing a lot is still going into Housing. Housing is not a domestic bubble it is a global bubble. Housing is out of control in most places that attracted investment dollars like Canada and Australia. So the next housing bust will be a global phenomena as well.


Interest rates and inflation are also directly impacted by the currency. USDINR was in the limelight in 2013 but ever since it has moved slowly causing the concerns to die down. However as we get closer to the 69 mark fears are coming back. Was the strategy to attract Bond funds into India and keep the rupee strong any good at a time when all the world was watching their currencies fall? There are no good answers. No we did not want a currency crisis in 2013. But can we avert one now? So we postponed a problem that is coming back to haunt us again.


However my long term view remains that USDINR is in a bull market. This is the easiest statement to make in a Keynesian economy. Why? Because that is how they all operate. Keep weakening your currency and trying to grow the economy till debts do us part. So this is the yearly chart of the USDINR dating back a century. What do you see. A 100 year bull market. So during an Economic Spring, weakening your currency actually pays off. Each devaluation acts like a stimulus package. However there comes a point when this does not work any more. This is especially true if you have funded your Economic growth with foreign money. We opened our Capital account slowly since 1992. Most of the foreign money came in after 2002. So wave II of 5 on this chart when the rupee strengthened to 38 occurred between 2002-2008, a bull market. This money came mostly into equities. After that corporate borrowing and after 2013 some amount of government bond sales have expanded our external debt to over 25% of GDP. So unlike our Economic spring which was mostly funded by domestic money, our Autumn bull market had a quantifiable amount of foreign funding. So the 1992 currency devaluation caused the Harshad Mehta bubble. A devaluation today would be a crisis. The chart below shows that we are in wave III of 5 the most powerful segment of this move. There are multiple target levels based on all the channel lines. We will have to see how many are achieved. But close to 90 by the time wave III ends is not hard to imagine now.


 So we are watching a weaker currency and higher interest rates risking an outflow of money from the country. The only source of liquidity then that held up the market till Jan 2016 was domestic flows. This chart tweeted by , makes the picture quite clear on how big the flows this year actually were. There were not only big they were consistent month after month. These flows were the impact of the positive social mood in the public at large after the Modi election. A failure of markets to revive from here would do permanent damage to the broadly positive sentiment that was persistent till now. The damage might not be easily repaired.



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Catch 22

The Indian Macro picture is in the Midst of a Catch 22 situation. No matter which side you push you trigger another crisis. This is usually what you should expect in an economic winter that has not fully resolved itself from the complete cycle. In a year that every currency was beaten up ours held out. We take a pat on the back for it. However we have done so at the cost of allowing our exports to fall in value terms. The rising dollar brought down both sides of the equation imports from lower commodity prices and exports from a lack of re-pricing. And the tool used to achieve this was nothing more than bringing in a lot of money into Indian debt. When that limit exhausted itself then another lot was opened up at the same time that interest rates were cut 50 basis points.

I wonder if this is s smokescreen of sorts. Bond yields could not stay down for more than a few weeks and are headed higher again. So the window for debt that was filled up so fast was only meant to keep off the pressure from our bond market imploding along with the currency? The measures taken by RBI in hindsight will appear like only quick fixes to a problem that is half a century deep.

Can the RBI really fix this? The real problem then is not fixing what you can’t but what you can. How to write off unreported and restructured debt that really cannot be paid back. How to deal with the idea that global liquidity that has mostly financed the Indian growth story will suddenly dry up one day. 

And since we have not passed on the positive effects of falling oil prices to the economy will we be able to deal with the reverse situation, rising commodity prices or simply food inflation around the world. Even a jump in inflation just on the back of a weaker currency would be damaging. Instead of importing deflation we would start importing inflation. For these reasons and more the RBI was unable to act on rates at its recent meeting.

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The only tool in the hands of the RBI is to expand monetary policy and shower inflation onto the people at large. If not we will have to go over the painful deflation, that any economy that follows the current monetary system, adopted by the rest of the world, has to. The next question is how fast will we bite the bullet and move on. It would be advantageous to India to not kick the can down the road. Allowing things to melt and rebuild quickly has major advantages. It disallows anti-social forces to take root, in the midst of the economic contraction that lies in between. Because market calamities cause financial pain and depression they also support anti-social thinking. The longer a depression is allowed to persist the longer time it gives these forces to work their way into the minds of the people at large. Quick action and moving fast usually brings back animal spirits in favor of the general good. So that is what I can hope for from the RBI and the government.

The Cycle will complete its course –

Apart from setting the above expectation the Indian economy is now headed into the final winter phase for its generation long economic cycle. We have played catch up with the rest of the world by walking down the globalization path starting 1991. After that there was no looking back and we are now part of the global economy and affected by the same economic forces that impact everyone around the globe. Our only strength is our demographic profile and our ability to bounce back. But that does not mean we do not face a winter of our own.

The Sensex Gold ratio chart continues to show that we have been unable to go above the 2008 highs to date. The index is still below the 50% retracement mark here. The coming asset price deflation in India accompanied by our own currency adjustment [mild word for a USDINR target that can end up in triple digits or at least close to 90], and the potential for a major Gold price rally in the coming year are headwinds that should push down this ratio to a level from where the new Kondratieff Spring economic cycle can start. That is called the birth of an economy because we start from scratch and aim to achieve the aspirations of a new generation.

Gold has formed a year long ending diagonal or wedge pattern on the way down with sentiment reaching below 5% bulls. This will be a long lasting bottom, and should be accompanied by a trend reversal in the dollar itself.

However the decline of the dollar index this time will not be the same as the one witnessed since 2002. At that point it indicated inflation of global assets but this time it is more likely to reflect US deflationary trends and an unwinding of the carry trades in Euro and Yen. On the other hand the contraction will make the dollar strong against EM currencies or those with large dollar denominated debts. This will therefore be in general bearish for world equities and bonds. Temporarily it might support commodities but in particular it would be good for Gold and Agro commodities.

There is no change in my view that Indian interest rates at some time will shoot up in the bond markets irrespective of whether the RBI makes an official announcement of rate hikes. The reasons could be a guess between currency management to Agro based food inflation or just because of an outflow of funds. Hard to say. But that will mark the end of the winter phase and interest rates in India will permanently drop from there for a long time to come.

If you understand the Economic cycle that repeats over and over again and prepare for it there are lots of opportunities in the above. Else it a painful period for you that lies ahead. If you only like a period of growth and rising stocks the good news is that it might not be far away as we enter the final year of the Winter cycle and are already pushing hard for quick deleveraging.

In 2016-2017 we may face the same crisis related questions that the United States faced in 2008 or 1932. How we deal with it will pave the way ahead into the new Economic Spring bull market that lies next. A 20-30 bull market may develop from there

The oddest case would be that this unwinding process that I have outlined to complete by the end of 2016 stretches out into a slow and extended period of market gyrations in both directions with a lot of sector rotation. It would be awkward but we would have to deal with it. But the moves by RBI have already moved us from a Marathon to a Sprint so expect speed.

I expect a quick fix and similar to 2000-2001 we should complete this business cycle before the rest of the world. Unfortunately the National party that has taken power to steer us through this period of crisis is the same as the one that was around in the previous period. And despite all their good efforts the market punished them in 2004 with an election loss. The reason is that public at large does not understand economics. They are driven by mood. Coming out of a bearish business cycle that was turning around in 2004, the negative mood associated with that bear market led to a negative vote against those in power. They failed to recognize the measures in the power and road sectors that were major reforms of that time. I wonder if the same will repeat. The good efforts that have been put in and will continue over the next year have nothing to do with the natural course of long term economic cycles that need to complete. The coming winter is capable of making people remorseful of those in power irrespective of their gainful efforts. This is behavioral and something we will watch for closely in the next election.

For now be prepared for the coming winter, it is already here !! 

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