The market benchmark Nifty has been hitting fresh highs for the last few sessions as declining coronavirus cases fuel hopes of an economic recovery in the coming months. Inflation, however, remains a major threat and has the potential to derail the rally, analysts say.
Shankar Sharma, VC and Joint MD of First Global, is of the view that inflation and the resultant hardening of bond yields is the biggest risk for the Indian market.
"The risk to India right now is really an inflation problem. If that somehow is contained and the bond yields don't go up, I think we are going to enjoy a very long-lasting bull market in India without any doubt. I mean, I'm pretty clear that the risk-reward equation is extremely skew towards rewards right now," Sharma said in an interview with Moneycontrol.
If bond yields harden, then equities, obviously being on the other end of the spectrum, would suffer. As long as bond yields remain at around these levels, the equity market bull run would remain intact, Sharma said.
On June 4, the Reserve Bank of India (RBI) Governor Shakuntala Das said CPI inflation for FY21-22 was projected at 5.1 percent. For the first quarter of FY 22, inflation is expected at 5.2 percent, Q2 5.4 percent, Q3 4.7 percent and for the fourth quarter the forecast is 5.3 percent.
"The rising trajectory of international crude prices within a broad-based surge in international commodity prices and logistics costs is worsening cost conditions. These developments could keep core price pressures elevated, although weak demand conditions may temper the pass-through to consumer inflation," Das said.
He added that a normal southwest monsoon along with comfortable buffer stocks should help to keep cereal price pressures in check.
Read more: RBI Monetary Policy: CPI inflation projection rate at 5.1 percent for 2021-22
The market seemed disappointed with the RBI's projection of inflation as Nifty retreated from the record high level and closed in the red.
Inflation erodes the purchasing power of the people by reducing the real income, therefore affecting the revenue of the companies.
Read more: Rate decision on expected lines, then what is pulling the market lower from record high?
Retail inflation is used by the monetary policy committee (MPC) for policy formulation. RBI has been keeping the rates low and maintaining the status quo as the growth is yet to recover from the COVID-impact and inflation is staying close to the upper band.
"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," Nitin Sharma, Director Research & India Site Head, Fidelity International, had told Moneycontrol.
At this juncture, however, inflation does not appear to be an immediate risk for the market and even if it remains at an elevated level, the RBI is unlikely to raise rates.
"I don't think RBI will raise rates even if inflation spikes. Inflation is a risk but it is an acceptable risk. We are comfortable with this," said Sharma.
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