Core inflation is up to 4.2% indicating a prolonged pause in the interest rate cut by the RBI. Being much above the target, this will also impact rate-sensitive stocks in the short-term.
The market has been volatile this week. It started with a positive view but ended flattish for the Nifty, while the mid-caps and small-caps closed negatively. The two factors which impacted the mood of the market were the novel coronavirus (COVID-19) and continued high domestic inflation.
The COVID-19 fatality rate had stabilised over the past week with a drop in the number of fresh cases, but a sudden spike in deaths on February 13 and a record new cases in China and other countries impacted the global trends.
The key understanding is that the economic impact of COVID-19 will be much bigger than the 2003 Sudden Acute Respiratory Syndrome (SARS) outbreak. SARS had hit China's GDP by 1 percent but did not impact global growth. This time, however, China's share in the world economy at 16.3 percent is four times the 4.2 percent it had in 2003.
World economic growth could slow by 0.4 percent if the standstill in China continues, as per IHS Markit. The International Monetary Fund (IMF) had projected 3.3 percent world GDP growth in CY20 in December 2019.
Experts view is that the epidemic will dissipate from June as temperatures rise in summer. They thus feel that the major economic impact will be in Q1CY20, and then diminish.
For India, China is the largest trading partner accounting for 15 percent of total imports, while total trade (export and import) in FY19 was $87 billion. We largely import manufacturing items of semi and final components.
Sectors negatively impacted will be auto and auto ancillary, due to drop in China sales and unavailability of components at accommodative prices; Pharma, due to a lack of availability of Active Pharmaceutical Ingredients (API - raw material) at economic prices; and Consumer Durables, due to unavailability of semi electrical and electronic components. Costs are likely to increase, thus impacting their profitability in the short-term.
Losses in revenue or exports to China is limited to the agriculture, auto, aquaculture and engineering sector. A blessing in disguise is a drop in crude prices due to slowdown in global demand, which our exchequers a lot, given our high oil deficit.
Indian chemical players with a robust supply chain will benefit from being a strong exporter in the international market. Textile will benefit in the medium to long-term since China accounts for 40 percent of the total world market in this segment, and new order enquiries have started.
Domestic metals and mining will also benefit as supply from China will reduce, volume and prices gain is expected for our self-sufficient industry. Overall, the world wants to diversify its high trade exposure to China.
India is emerging as a strong exporter in segments such as manufacturing, chemicals, information technology (IT) and engineering and can capitalise on “Make in India” in the long-term.
Consumer Price Index (CPI) in the last two months was very high. December was 7.35 percent and January higher at 7.59 percent, much above the Reserve Bank of India’s target. Core inflation is up from 3.5 percent to 4.2 percent on a month-on-month (MoM) basis indicating a prolonged pause in the interest rate cut by the RBI. Being much above the target, this will also impact rate-sensitive stocks in the short-term.
But RBI has done more quantitative easing (QE) through cuts in the cost reserve ratio (CRR) and open market operation (OMO), hence the effect of this inflation is unlikely to impact positivity of the bond market, at least in the short-term. Inflation has to reduce in the next two to three months.
Year-to-date, mid-caps and small-caps are outperforming since the domestic economy is expected to be much better than the bottom seen in 2019. The economy is expected to be supported by fiscal and monetary policies undertaken in the past six months and also benefit from an improvement in the global economy.
As a result, the broad market is expected to do well, in which mid-caps and small-caps will outperform. The segment which are placed well are consumption-oriented businesses, chemical, fertilizers and banks.
The author is Head of Research at Geojit Financial Services.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.
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