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Indian Economic Winter 3.0 - Macro Matters

26 Dec 2018 ‚óŹ 07:12 AM

Indian Economic Winter


26 DEC 2018

The Indian Economy has been warming up to the Economic winter since 2010 when all stocks with high levels of debt peaked and have been falling ever since. 2015 onward we started the final innings as the RBI governor finally pushed the banks over to report their NPAs and losses and start the process of restructuring private sector debt. The following 2 years we are attempting a beatiful leveraging as global headwinds were not pronounced giving us time to try and manage interest rates and avoid a bond market rout. For that reason India has been an out performer in the EM space. However, we maybe running out of bullets and will align with the global trade and economic headwinds that have now become real. The world is slowing down clearly. 

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What started in Europe and spread to China and then the rest of Asia, is now showing up from this quarter as a slowing in US growth. Net net we have a peak in world growth.

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India and US have been the last ones to hit peak growth this quarter and I already read research reports highlighting that for the US but not for India. No one wants to call out India for slowing growth given that bank credit and GDP numbers are still looking on a perch. What has not added up for the years gone by however, is the failure of earnings growth to support the idea. Nifty earnings growth have been project to grow 15-25% 2 years forward for all of the last 4 years but the actual performance is as follows. I think this one is out of Kotak securities. Clearly the CAGR seen prior to 2008 was never replicated but projections remains at the top end of forecasts.


No surprise then that Nifty performance also never went back to that seen in the pre 2008 period. Here is a chart from Ritesh Jain [] this morning showing the earnings miss by various countries and for India it stands at -15%. for this year already. But we are not alone


Among the reasons that Emerging markets appear relieved in a what appears like a equity rout in the US is that bond yields are not rising and the dollar is not rising. The two biggest headwinds for the EM space is missing. Not to say that they have fallen much more earlier and therefore much of the selling may appear done. The real question is what is likely going forward.

This chart shows the coming wall of coming debt maturities that is a matter of concern in the years ahead. Remember that after 2008 it is EM debt that shot up substantially almost doubling. Corporate debt has expanded across the world because of low interest rates that has allowed the worst of businesses to stay afloat. On the other hand the low rates have also financed non productive activities.

Let the charts speak to start with here is the Wall of Maturities coming in over the next few years. This is a reason to believe that the calm before the storm is just that. With so much debt repayment coming up it is hard to say that the going is not going to be tough. A strong dollar will not help neither will rising interest rates. But then it is a chicken and egg situation as to what will drive what. This chart was published online by Daniel Lacalle.

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The MSCI EM currency index is telling us a story. While there are many Alternate views out there on what the dollar index should do, the question in my mind is whether it sill make that one final dash to 100 before going down. But 100 is not far, only another 3% away. The real concern is on the impact the interest rate differentials and the on going quantitative tightening is going to have on dollar demand for all the debt that has been floated in the last decade. The chart below shows that the EM currencies fell in 5 waves marking the start of a bear market. This bear market is not over. We are bouncing in a bear market rally for the EM currencies and so far after months we have not made it back to the wave IV resistance even. Will we? The bigger problem starts with the next 5 wave decline resumes and it will be equally big to the first. This will make the problem of rolling over debt above appear even more acute. In short another EM crisis is looming in the future.

em currency

But debt is not only an EM problem. In the US there are enough stories of companies using cheap credit to finance exhaustive share buybacks. In some cases companies have gone overboard borrowing for this purpose alone to boost profits and Mcap as part of a growth strategy. In the process many balance sheets maybe permanently damaged. Corporate debt as a % of GDP is now at the highest level since 2009. David Rosenberg produces this chart.

corp debt

At the same time Share Buybacks announced for 2018 are at a record high.


This problem is now out in the open especially in the case of General electric company. The stock is almost close to breaking its 2009 lows and the loss in billions of market cap is now being equated with the amount spent on Share Buybacks even when the company was Cash flow negative. The sheer loss to shareholders is now being examined. There will surely be more skeletons coming out on this topic in the future and maybe Share Buyback laws will change again. But for now the damage has been done as most CEOs are compensated for Mcap gains with Stock options and that drives them to act in line with their own wealth creation at the detriment of the companies involved.

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It bothers me when companies like Infosys sitting on piles of Cash not knowing what to do with it does not simply pay more dividends instead of wasting it on share buybacks that serve no economic purpose. If you do not know what to do with the money give it back to investors and let them decide.

The trend of cheap money however has allowed many poorly managed companies to survive and stick around allowing for a lot of misallocation of capital. This has lead to the creation of zombie companies - defined as companies that are unable to pay back even the interest on their loans. They survive by borrowing more money to stay afloat. This is similar to a company that is due to be marked down as an NPA being given more money to pay interest and appear as a good asset on the balance sheet. In other words it is nothing more than a ponzi scheme where more money has to be raised to pay off previous borrowings. This chart from shows 15% of the 1500 large caps in that category.

zombie companies

Rating companies should have first hand knowledge of this and Investment Funds should ideally base their decisions on it. But in a world that became starved for yield everyone has been taking on more risk. Most liquid/debt funds in India invest up to 60-80% of their money into lower rated debt. On examining a few for a relative I found large exposures to less than A and B rated companies in so many funds that it is daunting. The object is to draw a higher yield that can justify the fees. However in a liquidity situation a lot of these investments can go dry. For this reason after the ILFS fiasco funds have been allowed to demarcate illiquid debt into a separate basket. It will make the fund appear prettier to new investors but does not take away the risk. The problem lies with the pace at which ratings will change in an economic slow down or crisis. Right now all appears too good to be true though. Even as the following chart shows how a larger number of companies than ever before fall in the category of lower rated debt and on the edge of change.

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If you somehow believe that India is not a net borrower then think again. After the government backed off on spending the private sector has had no other option. This shows up in the numbers and is behind a lot of the NBFC lending growth as well. So if you hear about the RBI and government under pressure to lower interest rates you know why. There is a good reason. But this can only be done in the face of slower growth that is not inflationary. 

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The tug of war between inflation and deflation has been fought by policy makers for years. But by the time we slow down inflationary trends growth also appears to fall off a cliff and then lower interest rates does not work on day one. It takes several cuts before we can ignite some fire again. Worst case scenario the government steps in again with MSPs, farm loan waivers, Pay commission and what else. However at the end of an economic winter how will all of this work? It will work till it stops working. The following chart from my recent data update will come as a surprise. Even as we have moved back and forth on rates for years with every move inflation has made a lower and lower peak. This may sound very bullish to those who believe that this is a sign of economic success. But it is not. Prices can fall either if you become very productive or because you face the lack of demand. The lower tops and bottoms in the CPI series to me is a trend toward outright deflation.


As Indian debt ratios have peaked and even as headline credit growth has bounced back, the two trends appear opposite to each other. Updated up to March 2018 the credit data shows that debt to GDP has started to decline. This is not good for the economy. When an economy feeds on credit to grow in the modern world a trend of declining credit to GDP shows slack in the economy. The failure of lenders and borrowers to see eye to eye. Lower interest rates maybe a starting point but results may not show up at the drop of a hat. Add to that borrowing costs of banks that limit their ability to lower rates beyond a point. 

debt gdp india

The real point is this. We are in an economic winter that results from slowing growth seen below and results in deflationary trends seen in Inflation data. Eventually lower GDP and inflation trends push up debt/gdp ratios at the end of a winter and require direct market intervention to revive growth. The chart above shows that govt debt/gdp peaked in 2002 [pink line].  It was a good thing as growth picked up on its own. But now, unless the government overlooks rating agencies and takes the baton to spend us out of a deflation, it is not happening. At some point of time they will do so, when there is no other way out to kick start growth. In the interim the deflationary trends will continue to push higher Non Performing loans across segments that were not thought as possible risky. Bad debts in NBFCs and a falling stock market are all going to be symptoms of a deflationary Indian Economy.

A long standing signal has been the inability of the stock market indices to beat inflation. I said that right. All time highs in the stock market indices combined with falling inflation rates seen above have not resulted in the Sensex/CPI or the Real-Sensex or Sensex adjusted for Inflation to show a new high since 2008. In other words stocks have not beaten inflation at an index or Mcap level. Some sectors did well but not the market. A repeat of what we saw in 1992-2001. Wave wises it looks like a triangle in wave b that just witnessed a false throw-over/breakout above the line but has fallen back. The risk being wave c down long term on this ratio in a deflationary bear market before the Economic Winter ends for India.


India has been on the path of a beautiful deleveraging one where low levels of inflation co exist with low levels of growth for years slowly resolving the problem. But it does not always end that way. In a globalised world what is happening else where rubs off on speeding up the process. The US lived through a period of great demographics and similar debt ratios like ours in the 1920s, but what was a global debt deflation starting with problems in Europe rubbed off on the US financial markets causing the system to fall apart and needed intervention for a quick reset. We are in the midst of global turmoil due to excess debt everywhere and are part of the globalised world. As things shake up we will face the punches. For us the opportunity is to sort out the problems and take maximum advantage of it when things turn around. The government will be able to blame it all on the west again. But we do have our own problems and growth is not likely to pick up anytime soon unless we get a quick reset. The coming global debt and bond market crisis might then be a blessing in disguise as it speeds up the corrective process for the Indian economy.

The going will be tough, and it is going to be rough and you will need to be positioned accordingly as the dollar and bond market crisis promise to revisit the Emerging market world in the next year. 

Kondratieff and the EW Model

After a lot of analysis of the Indian and US market through the cycle data points I came to the following conclusions that broadly fit the cycle between the credit cycle based seasons described in the Long wave and the 5 wave progression in the Elliott wave model over 50-100 years.


I also concluded that India is 10 years behind the US on the cycle and I discussed that with charts in the 2016 Kondratieff cycle report. If you want a season wise explanation to the cycle for India read my first Kf report from 2010. 

Being behind 10 years means that US faced high inflation and interest rates in 1970-1980 and India did between 1990-1998, after that both saw interest rates and inflation fall leading to the start of an Autumn bull market.

US in 2008 went through the first deleveraging and bailouts for its banking sector as part of the winter process. In 2018 India is just starting to start that process and the recent NBFC fallout is just the first shoe to drop. Due to poor data and transparency related to the financial sector in and credit data in India it is hard to pin point how this will unwind but the above studies of the cycle make it clear as to where we are in the cycle and what to expect. 

In a winter we will deal with our debt, over investment, deflationary price trends, a drop off in demand, a spike in interest rates for private sector and lower rated debt. That spike should end with a top in interest rates and a bottom for equities eventually. At the end of winter and start of an economic spring interest rates in India will fall dramatically to levels not seen in post independence India. However what you need to be concerned about today is managing the situation from where we are to the peak in India's first modern day Financial crisis.

Till then we deal with the first serious stock bear market as the Sensex has now completed a 5 wave advance in a Supercycle degree bull market spanning 84 years, starting in 1934 with the inception of the RBI. While I started to write about the winter in 2010 that was only wave A of the 5th wave. I wrote the second report at the end of wave D [or 4th wave ] or the 5th, and now this is the last detailed report on the winter cycle at the end of wave E of 5 [or 5 of 5]. 


How will we know that the winter bear market is over. The interest rate cycle will peak and turn lower is one. If governments choose to inflate the debt then the Sensex/CPI ratio discussed earlier will complete wave c of the decline even if the main indices do not fall so much due to high inflation. And lastly the following chart of the Sensex/Gold ratio will be a guide as gold outperforms stocks during this phase and when this ratio chart declines to new lows below the neckline then we are in the last phase of the winter cycle. Here too the 2008 high has still not been surpassed.


The coming bear market corrects the 84 year advance in our financial markets and is the first Supercycle degree bear market in India that will coincide with our first Economic depression. All good things will then follow. 

The Truth About the Markets

Rohit Srivastava


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