Quarter 2, 2017.

Despite the continuous barrage of negative newsflow, which has us all believing that the world as we know it is coming to an end, India is up more than 20% percent. What a special country.
 
But wait – Poles and Mexicans are saying the same about their countries. After all, their markets are up even more, 38% and 31% respectively. What about Greeks, Italians and Hungarians? Same! Turks, Koreans, Chileans? Same! In total, 38 of the 40 markets we track are up year to date. It’s worth keeping our celebrations and our anxieties in this context.    

Back home, the aftereffects of demonetization are wearing off. Cashless adoption, which was up 3-4X at first, has settled lower. Growth has slowed down. Cash heavy businesses such as unorganized retail, microfinance, and small manufacturing, have all predictably suffered but adjusted. Life goes on. 
 
The new and shiny for Q2 was the Goods and Services Tax (GST). Rolling a dozen or so taxes into one, the new tax system promises to make doing business easier. There are some obvious benefits such as reduction in tax cascades and border check-posts. But there are also irritants, like different rates for similar looking things, e.g., 18% tax at air conditioned restaurants and 12% at non-AC ones. Its early days, and thus far the nation is confused about the whole thing. We are too. Over time, it will certainly result in higher tax compliance and lower logistical waste. It needs time.
 
Much less advertised, but almost as important, was RBI’s action against India’s largest distressed companies. Together, their borrowings constitute over half of the rotten bank loans in the system. RBI’s message to these companies is clear – restructure quickly or liquidate. This will be the first big test of India’s new, faster and more stringent, bankruptcy law. We wait with bated breath. In general, the pattern of Modi administration’s modus operandi remains consistent – tighten the leash, shake things up, inflict whatever pain needs to be inflicted, and get on with it. Critics be damned.
 
Portfolio Update
 
We initiated a short India position last quarter through index derivatives. This may seem at odds with our views so let us explain.
 
As bottoms-up investors we look for bargains wherever we can find them. When bargains abound we invest aggressively. When it’s slim pickings we stay away. We don’t move from cash to stocks, or stocks to cash, based on any macro view. The movement is simply a result of our stock specific research. Along the same lines, if we find index insurance contracts to be cheap then we buy those. It does not mean that we are actively betting against India.
 
As an analogy, imagine a fire insurance contract on your house. Assuming the insurance is not mandated, when you buy such insurance you are not predicting a fire, and you are most certainly not rooting for a fire! You just feel that the risk justifies the price paid. Moreover, all else equal your desire to buy such insurance should become stronger as the premium drops. Same goes for an index insurance contract. The price of insurance on Dollar denominated Indian market is at multi-year lows. This is partly due to the extrapolation of recent INR and market performance, but mostly due to technical factors in the options market. Simply, the price is factoring in how volatile India has been but not how volatile it can be. We bought a small amount of this mispriced insurance.
 
The upshot: in a market crash we’ll be relatively stable and in a fantastic rally we’ll look like dogs. We are OK with that for now. As we find other opportunities (we’re working on some exciting ones) our return profile will adjust. Overall we continue to be long India and extremely upbeat about its future. 
 
If you have any questions regarding this letter or your portfolio, please do not hesitate to ask.