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Moneycontrol Pro Weekender | A challenge for central banks

The worry for some is the inflationary consequences of the torrent of liquidity in the system

February 27, 2021 / 08:54 AM IST

Dear Reader,

Is the rise in global bond yields reason for worry? The markets on Friday certainly thought so, with the Nifty falling like a stone. It didn’t help that the Indian 10-year government bond market is having its own tantrum, with the yield ending the day at 6.235 percent. This FT story lamented that bond market investors suffered the worst start to the year since 2015.

But then, this jump in yields and the steepening of the yield curve happens in the early stages of every recovery — for instance in 2009 and back in 2004 — and is just a reflection of the economic rebound. This FT piece asked the question whether equity investors should be biting their nails about rising interest rates, especially in view of the massive fiscal stimulus in the US.

But US treasury yields were higher in January last year, so why the panic? Simply put, the market is much higher now, as are valuations, and punters have piled on to the reflation trade. As SocGen’s perma-bear Albert Edwards, sniffing blood after a long time, said: “Maybe, equity investors aren’t quite as convinced about a brave new reflationary world lying immediately ahead as most commentators seem to be?”

Well, if Indian investors were hoping a good December quarter GDP number would set at rest their concerns about growth, they have been disappointed. GDP growth for the December quarter came in at a lower-than-expected 0.4 percent from a year ago, at constant prices. Real gross value added (GVA) growth was 1 percent year-on-year, but take out agriculture and the rest of the economy saw GVA growth of just 0.3 percent.

What’s more, growth in private consumption in the December quarter was lower by 2.4 percent from a year ago -- this was the quarter in which pent-up demand and festive spending happened and that demand continued to shrink, throwing cold water on hopes of a quick turnaround. Rather surprisingly, gross capital formation is what has helped GDP grow, possibly the result of government capex.

Have expectations for the full year 2020-21 improved? That depends on whether you look at GDP or GVA. For the full year, projected GDP has been revised down from -7.7 percent in the first advance estimates to -8 percent now, while projected GVA has been revised up from -7.2 percent to -6.5 percent. How come? It’s because net taxes were expected to shrink by 13 percent in the first advance estimates, which has been revised down to a contraction of 23.1 percent. Since GDP is GVA plus net taxes, GDP is now estimated to be lower.

The GDP numbers show the services sector is a drag on the economy, no surprise since it has been the worst hit during the pandemic. Perhaps the key takeaway is that the exceptionally good corporate results for the December quarter represent only a very small portion of the economy and large swathes of the population continue to suffer.

That said, the GDP numbers are yesterday’s story. Our own recovery tracker shows the recovery continuing, with higher vehicle registrations, consumer sentiment and employment, although power consumption and bank credit were spoilsports.

Obviously, many of our stock recommendations are plays on the recovery. The December quarter was a turnaround one for the construction sector, which is back on the growth highway. The macro data showed that GVA in construction, at constant prices, was up a healthy 6.2 percent year-on-year. With the government’s focus on roads and other infrastructure, the cement industry should see strong sales —Ambuja Cement had a good December quarter and while Heidelberg’s was a bit mixed, its long-term growth prospects remain sound. VA Tech Wabag’s MD and Group CEO Rajiv Mittal told us that the government’s plans to boost water-related infrastructure will help. Ports are another priority and we argued that excess capacity should not be a concern for companies such as Adani Ports and Gujarat Pipavav, as tariffs and volumes improve. Even the battered and bruised housing sector is finally seeing growth and we discussed which housing finance companies to back after the recent rally. Stocks such as Cera Sanitaryware will also ride the housing market boom.

Thanks to the recent bout of nerves in the markets, some stocks are available at relatively decent valuations. These include Minda Corp and Subros among auto ancillaries; Engineers India, which is a good candidate for re-rating; Persistent Systems in the mid-tier IT space; and Mas Financial as a long-term bet. We also asked investors to stop chasing overvalued tech and consumer stocks that keep going up. And the cosy battery duopoly could be in for a shake-up.

Commodity prices have zoomed, thanks to a combination of recovering demand and constrained supply and we wondered, contrarily, what could knock the wind out of metal prices. One stock that has benefited is Hindalco -- it has even told investors how it intends to allocate capital in the next five years and beyond.

Analysts such as Goldman Sachs are saying we are on the cusp of a new commodity supercycle. The upshot: PMI data show rising margin pressure in both manufacturing and services. It could also feed through into inflation, aided and abetted by the high taxes on petroleum products. The obvious question to ask: How long will the Monetary Policy Committee’s accommodative stance continue? We also pointed out that the commodity rally could bring the euphoria in equities to a juddering halt because, as Bank of America said, 31 corporates, comprising 46 percent of the free-float weighted market cap within Nifty, are exposed to commodity risks. That throws into question the rosy earnings projections of analysts, underlining the need for caution, as Axis Bank MD and CEO Amitabh Chaudhry told us.

Could the combination of a moderation in growth expectations and higher interest rates as a consequence of massive government borrowing send the equity markets into a sulk? It’s up to the central banks now — the current tantrum is a test for them and so far, they have stepped up and delivered what the markets wanted, every time.

This time though, some of them are worried about the inflationary consequences of the torrent of liquidity they have unleashed. In a speech titled ‘Inflation: A tiger by the tail?’ Bank of England chief economist Andy Haldane said, “There is a tangible risk inflation proves more difficult to tame, requiring monetary policymakers to act more assertively than is currently priced into financial markets.” The tail risk is, as Albert Edwards points out, “despite the widespread certainty that the Fed can micro-manage the equity market, and levitate it at will, the real shocker would be if the Fed lost control in any impending equity riot”.


Manas Chakravarty

Manas Chakravarty
Manas Chakravarty