Moneycontrol Pro Weekender | The Bullwhip Effect 


Dear Reader,

With US consumer inflation at 6.2 percent for October — a 31-year high — and even Japan, where people had forgotten what inflation was, seeing producer prices increase at the fastest pace since 1981, inflation is obviously on top of the mind for investors. Could those Titans who hold up the markets — central banks — be wrong about their faith in inflation being transitory?

The Bank for International Settlements (BIS), aka the central bankers’ bank, should know. In a recent Bulletin, it says one reason prices are rising is because of the ‘Bullwhip Effect’. This occurs when relatively small surges in demand have progressively larger fluctuations at the wholesale, manufacturing and raw materials supply levels. It is so named because it mimics what happens when a person cracks a whip — a flick of the wrist results in the amplitude of the movement increasing as it travels along the whip, with the end moving the most.

Attempts by retailers, wholesalers and producers to hoard inventory to cushion themselves against the supply crunch lead to the bullwhip effect. The BIS Bulletin says, “Anticipation of product shortages and precautionary hoarding at different stages of supply chain have aggravated initial shortages (the “bullwhip effect”), leading to further incentives to build buffers. These behavioural changes have the potential to lead to feedback effects that exacerbate bottlenecks. In this respect, there are parallels between supply chain disruptions and the liquidity stresses in financial markets.”

The second reason for inflation, says the report, is the shift in the composition of demand towards manufactured goods and away from services — a consequence of the pandemic. This has exacerbated the bottlenecks. The more upstream the bottleneck, the more impact it has on the supply chain.

On how soon the bottlenecks will ease, the Bulletin says, “Once bottlenecks begin to ease, the feedback loops could operate as a virtuous circle to mitigate the bullwhip effects. In this way, just as bottlenecks have persisted longer than initially expected, their resolution could also follow more swiftly than currently feared.”

However, there’s a risk. Hyun Song Shin, Economic Adviser and Head of Research at BIS, tweeted, “But there is something of a race against time. So far, there is little sign of a broader wage-price spiral, but once the spiral takes off, bringing inflation under control will be a much tougher task.”

As far as the markets are concerned, though, the only bullwhip effect so far has been in egging on the bulls to conquer new heights.

Back home, higher US inflation and rising crude prices are weighing on the rupee. The rise in US bond yields has led to a firmer dollar, which is one reason why foreign portfolio investors are selling, the other being high valuations in the Indian markets.

To be sure, the economic outlook for India continues to be positive, with our recovery tracker indicating an excellent Diwali. Irfan Razack, Chairman and Managing Director of the Prestige Group, says the residential real estate sector will do even better in the current quarter. Jewellers such as Goldiam International and Thangamayil Jewellery saw strong top line growth, indicating robust demand. Nor is it only domestic demand, exports too have been firing on all cylinders, for instance at Eicher Motors.

We analysed what lay behind record festive season sales and the impact of ‘revenge travel’ on EasyTrip Planners. Solid top line growth was posted by Zee Entertainment, Page Industries, Cholamandalam Investment and Finance, Shemaroo and Kajaria Ceramics.

But as Goldman Sachs has said, although it expects strong GDP growth next year, which in turn will drive earnings growth, that recovery is already priced in. Our Samvat 2078 forecasts here and here say that investors should keep in mind India’s multi-year growth cycle ahead, but acknowledge that investors might prune return expectations and alter their asset allocation accordingly. While going about asset allocation, investors would do well to keep track of the transaction costs on their investments.

The good news is the government continues to push the pedal on reforms. This week, they made major changes in the public project and procurement rules and nudged discoms to adopt better financial practices. Market regulator SEBI has got the exchanges on board to implement T+1 settlement in a phased manner from next February.

On valuations, the response by investors to the Paytm issue was less enthusiastic than for other recent issues, perhaps an early indicator that FOMO is losing its grip. Ola’s credentials as a disruptor will be tested by its ability to deliver.

Nykaa, however, had a stellar debut and the Zomato stock continued to scale new highs, even though losses widened. Analysts are valuing platform companies using a completely different set of criteria from that of conventional firms, exactly as happened during the dotcom boom. This is what usually happens when valuations get frothy and analysts are hard pressed to justify them. We pointed out that in spite of the humongous amount being poured into start-ups, there’s still a long road for angel investors in India.

Inflation has been hitting company bottom lines, with margins being squeezed as input costs rise. This week, we considered whether investors should worry about the lower margins seen in the quarterly results of several companies. These include Vidhi Specialty, M&M, Britannia, Radico Khaitan, Nuvoco Vistas and Godrej Consumer Products.

Could cryptocurrencies be a hedge against inflation? The use of cryptocurrencies is steadily expanding — for instance, consumers and businesses in the Asia-Pacific region can now use bitcoin-linked Mastercard credit, debit, and prepaid cards for regular purchases. We kicked off our Crypto Learn series this week with a look at blockchain, while, in our Crypto Conversations series, we considered whether this is the time to get into crypto gaming. Given the increasing popularity of crypto assets in India, it’s high time the government clarified its stand on it.

During the week, we looked at whether the SBI stock still has some juice left, despite its rally; the earnings risk in pharma; Ujjivan’s never-ending road to recovery; Sun TV’s flat quarter; what next for IndusInd Bank after the whistleblower allegations; the Sapphire Foods IPO; who loses as Tata Motors gains; and we updated our Herd Immunity tracker.

So far, the climate change talks at CoP26 seem to have been mostly hot air, and we need to keep our fingers crossed for a satisfactory outcome. It isn’t going to be easy, with a lot of wrangling over who will bear the costs. We outlined five steps to fulfil Modi’s Panchamrit promise and discussed how India has missed two buses towards energy self-sufficiency. The investment industry is getting serious about combating climate change and even central banks are climbing aboard the green bandwagon. Green initiatives by companies are in the limelight, but investors may be ignoring some risks, as we pointed out in the case of Inox Wind.

The much-ballyhooed meeting of China’s Communist Party this week anointed Xi Jinping as supreme leader, putting him in the same league as Mao and Deng. Our Eastern Window columnist, with years of experience in Beijing behind him, wrote that China’s growth model is at risk as Xi tightens his grip. This FT story said China is slowly turning inwards, a marked change from its earlier policy of embracing globalisation.

I could discern no sign of any turning inward in the full text of the resolution adopted at the plenum. But then, my eyes had glazed over after reading mind-numbing, brain-frying, bromides such as this:

“We should continue to apply systems thinking and ensure coordinated implementation of the Five-Sphere Integrated Plan and the Four-Pronged Comprehensive Strategy. We need to ground our work in this new stage of development, apply the new development philosophy, foster a new pattern of development, and promote high-quality development. We should deepen reform and opening up across the board, promote common prosperity for all, and build up our country’s strength in science and technology. We should develop whole-process people’s democracy and ensure it is the people who run the country.” That last line, though, was good for a laugh.

After that, it was a blessed relief to read about Elon Musk’s online antics.


Manas Chakravarty