Is India trending towards a Hyperinflation regime?

Photo: The Balance

Before starting this write up let me up a small caveat: Don't associate the economic activities of India and the US with stock prices. The current rebound in the S&P 500 or Nifty50 is not reflecting what some believe is the sign of a stronger economy; though Donald Trump's US economy is in much better shape than that of Narendra Modi's India.

It is really surprising to see that, as the economic data gets worse, traders get more aggressive in buying stocks -- something resembling to the happenings In Zimbabwe, almost a decade back. 

Meanwhile, we are reading a lot of media reports which speaks about the vast economic damage COVID-19 pose to the world economy. Recently, economists from the IMF released a report, predicting a 6% contraction in global GDP, further adding that Covid - 19 epidemic, could bring along with it, the worst recession since the Great Depression, and its effect on the global economy could be more devastating than the 2008  Financial Crisis. 

In the U.S., the macroeconomic data is coming in much worse than forecast, ditto is the case for India. But the stock markets in both the counties, chugging along North, isn't? 

So,  why are Indian markets so buoyant along with most of its global peers? Queer and Sardonic, Right ?

One reason, could be the threat of an impending spell of hyperinflation, as QE in the form massive economic packages, are being implemented in both East and West.

Let us dig deeper..

The investopedia defines Hyperinflation as an exponential rise in prices and is generally associated with a collapse in the underlying economy.

A thorough research by the  website, Commodity.com (recommended by the CNBC & the Huffington Post), uncovered some startling  facts:

• Hyperinflation occurs when a country experiences very high rates of inflation, which erodes the real value of the local currency, and causes the population to minimize their holdings of local money. 
• It is argued that hyperinflation often occurs as a result of some kind of stress on a Government's budget. This is because the root cause is a large Government deficit which is financed by money creation rather than other options like increased borrowing or higher rates of taxation.
• The prices in Zimbabwe doubled every 24.7 hours during hyperinflation.
• Physicians in Weimar Germany diagnosed patients with a disease caused by hyperinflation.
• The Greek government stopped collecting taxes during hyperinflation.

Moreover,  there is an excellent Infographics at Commodity.com, with headline: Hyperinflation Illustrated: 5 Times Currencies Crashed, which I feel the readers of this blog, will find interesting and fruitful. 

Coming back to Invstopedia, we see the following why QE didn't cause Hyperinflation:

Many feared that QE would spell hyperinflation for the U.S. economy following the economic crisis of 2008. The crisis, however, was largely a deflationary phenomenon and the money being injected into the system by QE, as seen by the spike in the M0 monetary base, was by and large retained by the financial sector, with the more important M2 money supply remained fairly stable. 

Hyperinflation is an exponential rise in prices and tends to occur not when countries print too much money; instead, it is associated with a collapse in the real underlying economy. The printing of money is a desperate effort to maintain stability and prevent production from coming to a halt, as what happened in post-WWI Germany and during the 2000s when Mugabe headed the government of Zimbabwe. 

On the other hand, the U.S. economy remained productive during the period of the Great Recession and only saw very modest increases in inflation.

Now let us consider the conditions in India:

The GDP growth nosedived to a 11-year low in FY2019-20 at 4.20% and the growth in the January-March 2020 quarter plunged to 3.1%, the lowest since the GDP base year was revised to 2011-12.

This suggests that Indian economy deteriorated significantly, well before Covid-19 hit us. The budget estimates for FY21 is now way off, having severe implications on government borrowing and interest rates. More borrowings means more pressure on Interest rate trajectory. 

It is well known that hyperinflation builds on a depleting economy with too much money supply. 

The second very important point is that: Indian currency is collapsing and that too very pathetically. 

Now, we should not consider the demand - supply equation of the US with that of India, because of the structural problems of Indian economy and its burgeoning population explosion, which will keep the domestic demand ticking. 

With factories closing down and workers there back home, a large amount of money from the middle class will chase too few goods. As a matter of fact the price of essential commodities have already risen by 20/30% at least in Mumbai, during the last 2 /3 months, which will show up in future inflation data. 

The US economy during recession was kept cool by Chinese Goods and its chain of departmental stores, which is not the case with the present India. 

Besides, India's middleman culture persists even though both the UPA and the NDA have both been trying to give the farmers a free hand and eliminate this mysterious hand, placed in between, Buyers and Sellers  

Also, though during Great Recession the US banks had bad loans and toxic assets on their balance sheets, due to the housing bubble burst and its aftershocks, like India's NPA crisis,  but the banks there used the increased money supply to shore up their balance sheets,  through increased credit offtakes, but in India this is not happening. On the countrary, the Indian banks are accumulating NPAs and a backlog of pending interest payments due to government's deferment order, following Covid - 19 catastrophe.

Another argument put forward regarding US avoiding hyperinflation is that due to economic uncertainty during recession, people and businesses choose to hoard their money rather than risk investment and potential loss, forcing the producers to lower prices in order to clear inventories. 

But in India, large scale displacement of factory laborers, will put pressure on the production graph,  like what is happening now, raising supply issues, spiking up inflation, in the near future.

In India the demand destruction which most economists speak today, due unemployment problem referring the Phillips curve, misses the wood for trees. The inverse relationship between the two as shown  A.W. Phillips differed in the period between 1970’s and 1980’s when prices often rose faster than wages. The relationship between the two variables infact became unstable, during that time span. Now,  a similar situation exists in India due to wage shrinkage.

Therefore, the analysis shows there is a likelihood of an increased chance of higher inflation (if not Hyperinflation) at least in the Food sector,  in India in the immediate future unless the NDA government takes a proactive stand. 

But,  there is no need to be unduly worried for the stock market participants, as according to Matthew Tuttle, a money manager with Tuttle Tactical Management and author of "How Harvard and Yale Beat the Market", stock earnings and inflation move together. This theory was later seconded by a 2004 Harvard study by John Y. Campbell and Tuomo Vuolteenaho.

Or in other words the share prices will move north in times of hyperinflation, driven by the overall increase in prices of all other goods and services, giving a cascading effect on positive sales, profit and dividend earning figures of organizations.

Yes, it happened in Zimbabwe, as their economy was collapsing.... its stock market was soaring and soaring in 2008, till one had to carry a trolley of currency to buy daily necessities.

Taking cues from that (and I'm not trying to scare you... 😂😂) we might witness prolonged bouts of Bull Rush in the Indian bourses, primarily based on the two hacks:

• Banks are no longer safer to keep money, especially in a lower interest rate regime. 
• Indian economy is collapsing and for the moment I don't see any light at the end of the tunnel. 

Conclusion: Shares generally do well in a hyper-inflationary economy, but only if you hold on to the investments over the longer term. However, it is wrong to give a generalized view, as it seen that different groups of equities seem to perform differently during high inflation period - - value stocks perform better in high inflation periods than growth oriented stocks.

Some sectors which could give good returns are: Commodities (Metals, Oil, etc),  Telecom,  IT,  Real Estate, etc. The bull run, in the stock market is likely to continue. So,  it is time to do cherry picking and inflate our investment basket. 

But there is also a caveat: Historically speaking, share market generally prior to the onset of a recession, and its trough before the end of a recession.

Therefore, timing our investments based on the economic cycle has been rather unreliable, even if long-term bull markets do tend to correlate with economic expansions. 

But,  one thing is certain: as long as central banks worldwide continue to provide unlimited liquidity to financial markets and Corporates continue their share buybacks sprees, we might see the BULL rush continuing in Dalal Street; with occasional bouts of selling.

Followed by another: the consensus view is that first deflation will show its fangs, then rocketing inflation bullet is likely to hit our economy. 

So, be optimistic but don't get carried away by the Bull Storm. All the best!