Investors Flee India’s Inflation War

02/11/2011 4:13 pm EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

Want to see why investors worry so much about the world’s emerging markets that they are taking money out? Just take a gander at India.

In an effort to fight inflation, the Reserve Bank of India has raised interest rates seven times in the last 12 months. So far, the effort hasn’t slowed inflation—India’s wholesale price index, the Reserve Bank’s inflation measure, was up at an 8.43% annual rate in December. But it does look like the interest rate increases may have started to slow the economy. Industrial production in India climbed at an annual rate of just 1.6% in December. That’s a big drop from the 3.62% rate of growth in November.

And, with inflation still racing higher, Reserve Bank governor Duvvuri Subbarao has signaled the Bank will keep raising rates, even though growth has slowed. The Bank’s benchmark repurchase rate went up another 0.25 percentage points to 6.5% in January, a two-year high.

The effect on the Indian stock market has been exactly what you’d expect. With interest rates headed higher and growth slowing, the Mumbai stock market was down 15% year to date as of February 10.

Economists have started to lower their forecasts for Indian GDP growth. For the fiscal year that ends in March 2011, the Indian economy is projected to show growth of 8.6%. Recent revisions from economists put growth for the fiscal year that will end in March 2012 at 7.7% to 8.1%. That’s not a huge drop—but investors fear that growth will be revised still lower.

That’s a real danger, since the Reserve Bank is giving no indication that it sees victory in the battle against inflation or indeed any sign that inflation is moderating. Bank governor Subbarao recently raised his projections for inflation for the fiscal year that ends in March 2011 to 7% from his earlier estimate of 5.5%.

With those trends in place, it’s hard to make an argument for investing in India now, and that means cash flows out of the Indian market are likely to continue and prices are likely to erode further.

Investors can, of course, make exactly the same arguments for Brazil, Indonesia, Turkey, China, and other emerging stock markets.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of December, see the fund’s portfolio here.

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