Indian Stocks Dip Following Anti-Inflationary Rate Increase: Time to Buy?

Includes: IFN, IIF
by: The Kennel

Indian index funds in general, and banking stocks in particular, cooled off fast yesterday
in the wake of the country's central bank's decision Monday to increase the amount cash lenders must set aside to cover deposits. It was the second time in as many months that the government has moved to curb inflation that accelerated to the fastest pace in more than two years.

Indian banks will have to keep a cash equivalent to 6% of deposits on hand starting March 3rd, up from 5.5% now. (There will be an interim rate increase to 5.75% on 17 February.) The measure is expected to sideline as much as $3.2 billion (140 billion rupees) in the banking system.

The central bank is making these moves to combat inflation generated by the unprecedented rate of expansion in the world's second-fastest-growing major economy. Wholesale price inflation increased to an annual rate of 6.58% as of 27 January and the central bank raised the overnight lending rate on 31 January to 7.5%, the fifth increase in the past twelve months, making funds more expensive to banks. The central bank had also just raised reserve requirements last month from 5% to 5.5%.

The $854-billion economy is projected to expand 9.2% in the fiscal year ending 31 March, which would top last year's record 9%, the Central Statistical Organization said last week. Industrial production in December surged 11.1%, breaking into double digits for the fifth time in the last six months according to the government's data department.

Investors were spooked by the pace of the moves by the central bank. It is unusual to see two material adjustments in the space of seven weeks; the implication is that the data the central bank staff are getting indicates that the situation is deteriorating rapidly. Indian index mutual funds and ETFs are off sharply this week and the financial sector has been particularly hard hit. The India Fund ETF (NYSE:IFN) was down 4% yesterday and down 10% over the last four trading sessions. HDFC Bank was down 6% yesterday and down 11% since last Wednesday.

IFN 1-yr chart

Ironically, it may have been concerns about the rising value of the rupee that lead - indirectly - to this anti-inflationary rate increase. In recent weeks the central bank is rumored to have been buying rupees to take them out of circulation and fight inflation. Speculation that the purchases had topped $1.5 billion in the past month sparked a surge in the value of the rupee to a 16-month high last week.

A more expensive rupee would be very bad for the products-and-services-export-driven sector of the economy, so, observers speculate, the central bank reversed course and started to sell rupees. However, this constrained the central bank to enact another immediate reserves requirements increase to trap the rupees in the banking system and prevent them from adding fuel to the inflationary fire.

Stepping back, these sorts of problems, while not easy to manage, are most definitely of a high-class variety (as opposed, for example to the sort of triage issues one faces coping with a sputtering economy with a grossly overvalued currency). The forces of inertia are pulling India inexorably upwards. Not to say that a random event such as a human bird-flu pandemic, sudden collapse of the dollar or China's banking system, or a WMD attack by terrorists couldn't stall India's growth...but the odds are good that in the long run, dips in the road such as this shall prove to be good buying opportunities.

Disclosure: Author is long the above-mentioned securities.

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