Inflation and the market: Should you be worried?

Source: Money Control

Rising commodity prices and a falling rupee have fueled inflation concerns on Dalal Street. Investors appear cautious as they worry that the rising prices may pressure the Reserve Bank of India (RBI) to revisit its low-rate stance.

Inflation is a rise in the cost of goods and services. An increase in inflation, as income remains unchanged, reduces the purchasing power and also affects investments. For the stock market, it is considered negative, as it impacts the return on equities.

The consumer price index (CPI)-based inflation, or the retail inflation, the key price indicator used by the RBI`s monetary policy committee (MPC) for policy formulation, fell to a lower-than-expected 4.06 percent in January compared with 4.59 percent in December.

The February retail inflation print is expected on March 12 and economists expect it to stay below 5 percent.

Should inflation worry the market?

Investors seem to be worried that inflation would make a comeback as commodity prices have been rising and bond yields are also increasing but most market analysts do not see inflation as a concern for the market at this juncture.

The RBI in its report on currency and finance on February 26 said the present inflation target of 2 to 6 percent was appropriate for the next five years to ensure price stability.

“Threshold inflation above which growth is unambiguously impaired ranges between 5 and 6 percent in India, indicating that an inflation rate of 6 percent is the appropriate upper tolerance limit for the inflation target,” the RBI report said.

The government had in 2016 notified 4 percent CPI inflation as the target for the period from August 5, 2016 to March 31, 2021.

Likhita Chepa, a senior research analyst at CapitalVia Global Research, said that the inflation tolerance band was appropriate for the near-future.

"Inflation should not be a major cause of worry to Indian investors as there (are) quite chances that our inflation would stay within the targeted band. Much of the rise in the inflation could be temporary due to rebound in oil demand and the base effect of prices as compared to the previous year," Chepa said.

The most preferred inflationary hedge, gold, was at its support levels and not signaling any unusual hikes in inflation. "Therefore, medium to long-term investors can stay invested," said Chepa.

Pankaj Pandey, Head of Research at ICICI Direct, too, isn`t worried, as of now.

"Food is the biggest component of the inflation basket. Barring supply-side disruption, food-related inflation is not likely to be a problem. On the fuel side, it is expected to be largely rangebound with a negative bias," Pandey told Moneycontrol.

A marginal rise in inflation won`t affect the Indian market much, said G Chokkalingam, Founder and MD, Equinomics Research & Advisory.

"Unless inflation goes above 7-8 percent, you need not worry about it. India is in a better position as we have a record level of food production, so inflation risk will not be there. Asset owners, such as miners, commercial leasing companies will benefit from rising inflation," said Chokkalingam.

CPI Inflation remained above the six percent band for eight consecutive months since April 2020 before falling below six percent in December and in January too.

In its February policy meet, RBI revised CPI projection to 5-5.2 percent in the first half of FY22 from 4.6-5.2 percent. It also revised the CPI projection for Q4FY21 to 5.2 percent from 5.8 percent earlier.

High rate of inflation will be risky but in India, the inflation rate has always been around 4 percent and if it continues to be around the same pattern, it also happens to be a good indicator for the developing economy as around 5 percent return is considered to be risk-free return (FD) and they both together act as a balance," Nitin Shahi, Executive Director of FINDOC, said.

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