Inflation is the biggest threat to Indian financial markets

June, 22nd 2014

Dubai: The new government in India needs to urgently address inflation to stabilise the economic growth and sustain the overall positive sentiment on economy and financial markets, said Anoop Bhaskar, Head of Equities, UTI Asset Management Company in an interview with Gulf News.

Inflation data on last Monday showed India’s wholesale price index rose to 6.01 per cent on-year in May, from 5.2 per cent in April while the annual consumer price inflation was at 8.28 per cent in May.

The market’s recent rally is already showing signs of fatigue, largely caused by spike in oil prices caused by the crisis in Iraq. The surge in oil price is reflected in already high inflation and further weakening of the rupee.

The Bombay Stock Exchange Index Sensex increased nearly 19 per cent since January; the most among emerging -markets, as foreign investors bought $9.9 billion of local shares, the highest net inflow among eight Asian markets.

The gauge trades at 15.5 times projected 12-month profits, compared with the five-year average multiple of 14.5 and 11 time valuation of the MSCI Emerging Markets Index.

UTI AMC expects that there will be a qualitative consolidation in the market when the euphoria related to the elections taper off and investors take a closer look at the fundamentals.

“We have to be realistic about the underlying economy. From 4.5 per cent GDP growth at the current level the economy can’t rev up to 6.5 per cent overnight. The expectations are that the economy will reach above 6 per cent growth in 2016,” said Bhaskar.

A big bang decision of reforms from the new government is unrealistic and that is where the markets will have to be in sync with the reality. “The threat of inflation is for real and it needs to be addressed at the fiscal policy level. The current government which came to power with a clear majority has the opportunity to work gradually on the policy front to address the issue,” said Bhaskar.

With the economic cycle seen bottoming out and inflation at its peak, expectation in general is that with the right kind of policies the government can influence the medium term economic sentiment. However, for the short term, Bhaskar expects the markets will gradually become realistic on current valuations which could result in a correction between now and the budget.

In India inflation and inflation expectations are not largely driven by loose monetary policy as is the case with most part of the world. On the contrary the money supply (M3) has been contracting or has remained more or less stable.

Large commitments to social spending rather than capital expenditure during the last few years have created demand pressures in the market. Some of the social spending programmes which involve cash transfers to the target beneficiaries got translated into demand push inflation, particularly food inflation. In India food inflation is the highest among many emerging markets, so is the housing inflation.

“High inflation has forced high interest rates on the economy. Despite growing expectations of an interest-rate cut, for last several quarters the RBI has done the opposite because inflation has been very sticky. The market is eagerly waiting for the new government’s policy direction on spending plans,” Bhaskar said.

Although nobody expects a sharp decline in inflation in the next one or two quarters, investors are eagerly looking for fiscal consolidation that results in cuts in social spending. The first step towards such fiscal policy direction is expected out of the budget of the new government in July.

High valuations are also posing risk to the recent rally. “There is concern on the valuation. Some parts of the market have run ahead of the economy. The small cap stocks, the domain for the local investors seem to have gone over exuberant. I think the whole markets needs to take a breather. We expect it will come in July after the first budget of the new government or with the July quarter corporate results which should digest some of the recent gains,” said Bhaskar.

Source: Gulfnews.com