Macro Tsimmis

intelligently hedged investment

BUY India Fund (IFN)—cold shower for India…time to cozy up

Posted by intelledgement on Tue, 13 Feb 07

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

Indian banks will have to keep cash equivalent to 6% of deposits on hand starting 3 March, 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 Organisation 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 (IFN) is down 4% today and down 10% over the last four trading sessions. HDFC Bank is down 6% today and down 11% since last Wednesday.

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 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, say, to the sort of triage issues one faces coping with a sputtering economy with a grossly overvalued currency). The forces of inertia are aligned to inexorably fire up the Indian economy. 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 throw a bucket of icewater on things…but the odds are good that in the long run, cozying up to India whenever — as today — she is shivering and temporarily-out-of-sorts will strengthen the long-term relationship between subcontinental investments and your portfolio…and your ROI.

For our part, we are going to double dip here: we already own IFN in our in Intelledgement Macro Strategy Investment Fund, but we are going to add a position here in our spec fund, as well. As we write, the share price of IFN is down 10% from where it ended 2006 and that is just too tempting…we will buy at the close providing the price is $42.45 or less (minimally a 7.5% loss on the year) put a stop loss in at 20%. We will look to get a 20% ROI within three months or a 30% within six months.

Note: normally we expect the components of the speculative portfolio will be significantly more risky and higher maintenance than those of the investment portfolio and are at pains to warn that it would not be prudent to invest any sum of money that you can’t afford to lose in speculative portfolio components. Well arguably—given that we confidently own this same ETN in the Intelledgement Macro Strategy Investment Fund and we paid about 10% more per share for that position—this is an exceptional case. Indeed, we thought about buying double our normal allocation, but there are other attractive speculative opportunities out there so we are limiting ourselves to one scoop here. But Indian growth is not going away, short of a calamity on the order of a ten-foot rise in sea levels, nuclear war with Pakistan, or a killer avian flu epidemic. If you are feeling frisky here, this is probably as safe a bet as you will see in this portfolio.

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