Rising inflation is causing anxiety to policymakers, economists, and most households, but has not so far dented the exuberance in the stock market.
Consumer inflation surged to 6.30 percent in May 2021, compared to 4.23 percent in April. Wholesale inflation also rose sharply during the month to 12.94 percent as against 10.94 percent in April.
What is worrying is that most, if not all components of the inflation indices have recorded an uptick.
Economists say that a shortage of goods and services caused by the lockdown in many parts of the country is largely to blame for the surge in inflation. The problem is not so much excessive demand, but the inability of producers to meet normal demand, because of factors such as staff shortage and transportation issues.
Analysts believe rising inflation could be a concern for the Reserve Bank of India (RBI), but a hike in interest rates looks unlikely anytime soon.
Madhavi Arora, Lead Economist, Emkay Global Financial Services believes that the rising input costs and higher wholesale inflation will concern the Monetary Policy Committee, especially as the high latest inflation print would easily push up the average inflation for FY22 to 5.5%+ much higher than RBI’s estimate of 5.1%.
“However, they may still choose to look through the spike in inflation in the near term, with the monetary reaction function currently hinging more on growth revival becoming sustainable,” said Arora.
Economists say the demand forces in the economy remain weak but the concern is that the supply-side factors could continue to put upward pressure on inflation going forward.
“High global commodity prices, rising global inflationary trends, WPI inflation in the teens and sharp volatility of retail inflation bode ill for the RBI, which is committed to supporting growth,” said Anand Rathi Share and Stock Brokers.
“Much of the recent growth recovery is on account of the low base and stimulus effect. Accordingly, monetary policy accommodation is likely to continue for now. Yet, unless inflation is tamed, the extent of accommodation can come down,” it added.
Market shrugs off inflation concerns
Rising inflation is usually bad news for equities as it pushes up operating costs for companies, leading to lower profits. This, in turn, makes high valuations hard to justify, prompting many investors to reduce their exposure to stocks.
However, the stock market has so far chosen to ignore the problems that may soon arise from persistent inflation.
Benchmark indices Sensex and Nifty hit fresh record highs of 52,869.51 and 15,901.60, respectively, before ending at their highest closing levels.
The widely held view is that a steady decline in COIVD-19 cases and the gradual reopening of the economy will not only resolve the current supply-side issues, but will also bring about fresh demand.
“Positive newsflows on COVID cases, hopes of better monsoon, high liquidity support from global markets, better than estimated Q4 corporate earnings and benign policy status from the US Fed is lifting the equity market,” said Sudip Bandyopadhyay, Group Chairman, Inditrade Capital.
Tough the macroeconomic concerns remain, Bandyopadhyay expects a “hockeystick” type recovery for the Indian economy.
“However, there are valuation gaps in the market; fundamentals viz-a-viz market value,” Bandyopadhyay said.
Shrikant Chouhan, Executive Vice President, Equity Technical Research at Kotak Securities said investors are focussing on US Federal Reserve’s announcements.
“There is one thing on which market participants are focusing is the meeting of Fed which is due on Wednesday. Participants are expecting a neutral stance from the Fed chief and that’s the reason the market is moving upward,” said Chouhan.
Siddhartha Khemka, Head - Retail Research, Motilal Oswal Financial Services believes that the further direction of the domestic markets would depend on the monsoon, opening up of the economy in a phased manner, and the pace of vaccination going forward.
Technically too, Nifty remains in a positive setup and can see a move towards highs of 16,000, analysts said.
“The Nifty finally managed to hit the 15,900 levels but ended up closing a tad below. The zone of 15,900-16,100 is a resistance block and traders should be cautious around these levels,” said Manish Hathiramani, Proprietary Index Trader and Technical Analyst, Deen Dayal Investments.
A buy-on dips approach would be a prudent form of trading this patch. 15,700-15,750 is good support for the index and as long as that does not break, we are in the territory of the bulls, he added.