Inflation rears its head again FRONT RUNNING

The CPI and CFPI are up and there are fears that food inflation will continue to rise. High inflation could prevent RBI from reducing policy rates

Another day, another North Korean missile test. The week ended badly with the yen crashing and Asian equities seeing a sell-off as a result. In fact, there was currency volatility across most major markets for other reasons, too. The yuan gained, the USD lost ground, as did the GBP. The euro ruled strong given low inflation. The rupee was stable enough against this backdrop.

Traders around the world are liable to get a little skittish, given that the latest print on US inflation ran higher than estimates and headline inflation was close to the Fed Reserve’s target of two per cent. This may mean the Fed resumes its policy of rate hikes and accelerates plans to start unwinding the vast balance sheet created by its long series of quantitative easings. A tightening would probably cause exits from emerging market assets.

Indian policymakers have plenty of trouble on their collective plates anyhow and it seems inflation is also moving up again. Retail inflation as measured by the Consumer Price Index (CPI) was up year-on-year by 3.36 per cent in August as opposed to 2.4 per cent yearon-year in July.

The Consumer Food Price Index (CFPI), which contributes about 45 per cent to CPI weight has gone up to 1.52 per cent for August as against minus 0.36 per cent in July. The monsoon has hit transport and crops in some parts. There are fears food inflation will continue to accelerate.

Another worrying data point, the Index of Industrial Production (IIP) for July went up only by 1.2 per cent yearon-year. The cumulative growth in IIP for the period April-July 2017 over the corresponding period of the previous year stands at 1.7 per cent.

However, the Purchasing Managers’ Index suggests there was a recovery in August since both manufacturing and services registered at above 50, indicating expansion of business activity in August. This was despite continuing confusion on the goods and services tax front, with widespread complaints about difficulties with reporting. It’s anybody’s guess what the final tax collection will be, net of offsets.

Trade data could be interpreted in several ways. The trade deficit and the current account deficit (CAD) both shot up in the April-July quarter. The trade deficit hit $41 billion and the CAD widened to a four-year high of 2.4 per cent of gross domestic product. That’s clearly worrying and gold imports rose sharply, which is a poor sign since it wasn’t accompanied by corresponding rise in jewellery exports. But exports did rise and so did imports of other goods, which could be taken as a sign of encouraging activity.

The higher inflation could stymie the hopes that the Reserve Bank of India (RBI) will cut policy rates again. That might make a difference to the attitudes of foreign portfolio investors (FPI). The FPI attitude has shown some change in this fiscal already. In 2016-17, FPIs bought a net ~55,000 crore of equity and sold just under ~8,000 crore worth of rupee debt. So far in this fiscal, they have bought ~102,000 crore of rupee debt and just ~3,000 crore or so of equity.

This could mean that they were hoping for capital gains on rupee debt if the RBI cut rates. It could also mean risk aversion, with equity values spiking sky high. If FPIs assume that the RBI will just hold rates, they might change stance on their asset mix.

Emerging market equities are topping global performance in calendar 2017 with dollar-based returns of 26 per cent. Factory production and exports jumped in China in August. Earnings expectations were beaten in most emerging markets in April-June.

India was an outlier with results below estimates. The GST implementation uncertainty and the SBI Ecowrap suggesting that growth would continue to be muted due to structural issues are dampeners, too. The SBI report analyses data from 1,695 listed companies for 2016-17 and states that the issues are structural rather than being purely GST-related. In fact, it says the GST impact has been overemphasised and that destocking started earlier, in 2016-17. GDP growth is likely to stay below 6.5 per cent in the current fiscal. It also looks at the results of 2,395 companies in Q1, 2017-18, and points out that growth declined quarter-onquarter for 40 out of 69 sectors. The report attributes falling consumption to demonetisation while generic slowdown might have contributed to falling investment. Growth isn’t expected to rally until Q1, 2018-19.

In addition to the economic malaise, there’s the prospect of multiple state elections in 2018. There could be exits from India if FPIs decide they would rather go to better-priced emerging markets with more earnings visibility.

Domestic liquidity and sentiments remain strong, however. This could actually create conditions for companies to raise money easily through initial public offerings and debt offerings at low yields. The insurance sector, in particular, may be a beneficiary, given several issues in the offing. However, this sentiment could be affected by political considerations if the Bharatiya Janata Party is perceived to be vulnerable in the upcoming elections. It could also be hit by the ongoing crackdown on shell companies if the trading community fears an intensification of the Raid Raj. GST has also created a working capital crunch of sorts and this may translate into an unwillingness to commit funds into the markets if it continues.

Technically speaking, the Nifty has moved up above 10,000 again and could break through to a new high in one session. So the rally might continue on momentum alone. However, the next correction may be very deep.