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Can rising inflation derail market recovery? Here's what experts believe

Commodity prices have been rising of late, fanning worries that higher inflation rate may make central banks re-think their policy stance

May 27, 2021 / 12:43 PM IST

The Indian market is witnessing a decent recovery, taking heart from the signs of easing the second wave of COVID-19.

Market benchmarks - Sensex and Nifty - are getting close to their all-time highs of 52,516.76 and 15,431.75, respectively, that they hit in February. In the month of May so far, Sensex and Nifty have risen nearly 5 percent each.

This post-second wave of COVID-19 rally could extend and the market could soon hit fresh record highs. The risk factor, however, is the rising inflation, which is affecting investors' appetite.

Commodity prices have been rising of late, fanning worries that higher inflation rate may make central banks re-think their policy stance.

Retail inflation is used by the monetary policy committee (MPC) for policy formulation. With the growth yet to recover from the COVID-impact and inflation staying close to the upper band, the MPC has been on a pause mode.

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"Inflation will be the key metric to watch, where any increase beyond the comfort zone of central banks will lead to a reversal of the current easy money policies," said Nitin Sharma, Director Research & India Site Head, Fidelity International.

Read more: Lower inflation beneficial for financial stability, says RBI study

However, many experts believe the worries of a sharp pickup in inflation could be exaggerated.

"Our base case is that inflation in India will remain in a range around 5 percent YoY through FY22 and hence, the MPC should maintain status quo on policy rates and policy stance over next couple of meetings," said R Venkataraman, Chairman, IIFL Securities.

"The US Fed has, so far, not hinted at any tapering. The recent change in the US Fed mandate that allows it to tolerate inflation over 2 percent to compensate for the low inflation of the last several years also provides room to maintain the status quo. Unless the commodity prices accelerate sharply from current levels also, inflation may not be a risk to equity markets," Venkataraman said.

Inflation erodes the purchasing power of the people by reducing the real income, therefore affecting the revenue of the companies.

Gaurav Garg, Head of Research at CapitalVia Global Research underscored growing inflation is favourable for value stocks whereas it is not favourable for growth-oriented stocks.

"Due to the expansionary policy from past few periods inflation has been rising, and the rising fuel prices have also not helped the matters," he said.

"Food inflation has been a cause of worry which may subside if we have normal monsoon as predicted by the agencies. So if inflation remains under control, RBI is expected to continue with an accommodative policy stance. However, If the inflation continues to rise, FPIs may look for the rebalancing of their portfolios," said Garg.

Nitin Shahi - Executive Director of FINDOC pointed out the consistent rate of inflation between 4 and 5 percent is always considered a healthy rate in order to boost any developing economy in relation to the fixed interest rate.

"This phenomenon is considered good if applied in the normal market scenario but these COVID times have turned out unexpected and different. In these times, inflation may act as a barrier in the short run for recovery," said Shahi.

"A higher rate of inflation in these times where there is no increase in the wage rate would be impacted by the reduction in consumption which would, in turn, affect the overall demand and slower the revival process for the Indian economy," he added.

At this juncture, inflation does not look like a great matter of worry for the Indian market as RBI is expected to keep rates low for a longer time to support economic growth while the US Fed, too, has reiterated it will not let inflation go out of hands.

However, inflation is always a risk in any part of an economic cycle. For an emerging economy like India, a jump in inflation globally may hit the foreign fund inflows.

Suvodeep Rakshit, Chief Economist at Kotak Institutional Equities believes, in the current context, given the retail inflation basket and the external trade structure, pass-through of imported inflation at the CPI level will be manageable.

"FPIs will probably be more focused on growth differentials versus other emerging markets, mostly in terms of medium-term growth. If India’s COVID spread is under control and growth recovery is comparable to other economies, FPIs will not be too worried," said Rakshit.

"FPIs concern on India would be heightened if India’s growth and inflation moves are in adverse direction compared to rest of the EM space. Global monetary policy changes will be a significant risk to watch out for in terms of FPIs sentiment on India and EMs," Rakshit said.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Nishant Kumar
first published: May 27, 2021 12:42 pm

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