Where to invest during deflation

Go For Telecom, Healthcare, Utility Cos Where Demand Is Not Hit

New Delhi: Within months of inflation hitting the 13% level, the economy now faces a diametrically opposite situation. With deflation staring in its face, the near-zero level of 0.44% inflation is expected to go down further in coming weeks.
    If negative inflation sustains, it will affect economic activities and in turn performance of most companies as currently prices are falling not because of improved productivity but due to lack of demand. If deflation continues for a longer period, it will only worsen demand.
    "Deflation results in less demand, lower production and weak economic growth,'' said Citibank in a report "India Macroscope''.
    Negative inflation discourages investment in the economy. The real interest rate—difference between nominal interest rate and inflation—becomes very high, making funds costlier. The falling demand also takes with it the capacity utilisation of manufacturing units. This discourages investment in capacity expansion.
    As performances of companies will be hit, the Citibank report said, investors should be selective in their decisions. They must invest in companies whose products or services do not see too much of decline in demand. So, companies operating in healthcare, telecommunication and utilities like electricity distribution could be good bets. Their services will remain in demand even if the economy slows down.
    Investors also need to identify those companies where fall in prices lead to increased demand for their products, prompting them to produce more value-added products with greater economies of scale. In this category are those sectors like snacks and beverages, healthcare, utilities and telecom. Companies with strong balance sheets, which do not have much debt on their books, can also be considered for investment. As debtservicing would become difficult in the deflationary times, one should stick to companies (mainly in IT, health care and energy sectors), which are less leveraged, the report added.
    The report pointed out that the total investment in the economy may decline by 2 percentage points of GDP by 2010 to 35.7% from 37.1% in the current financial year.
    At the same time, companies operating in the capital goods sector should be avoided. Capital goods are required when companies are investing in either new projects or expanding existing facilities. But, as companies may do neither during deflation, the performance of capital goods companies may further dip.
    Similarly real estate companies too should be avoided. In deflation, the general perception is that prices will further fall. So, home buyers will postpone purchasing decisions, which will further increase the suffering of the cash-starved sector.
    Meanwhile, the IMF has said the world economy is set to contract for the first time in 60 years, as the deepening financial crisis would lead to the global GDP shrinking by up to 1% in 2009. In its latest assessment of the global economy published on Thursday, the IMF said that "more sustained, concerted policy actions (was) needed to revive growth'' in the economy across the world, as trade volumes have shrunk rapidly despite large stimulus packages announced by advanced economies and several emerging markets.