Investors turn cautious amidst high inflation and currency volatility
In July, India’s retail inflation soared to 7.44% from Q1’s average of 4.6% (April to June), exceeding the monthly consensus of 6.4%. However, the market remains relatively unperturbed to the Q2’s robust price upswing, attributing it to fleetingness and expecting moderation in Q3.
While India has so far experienced limited impact from elevated inflation figures, prematurely assuming that inflation’s impact on the domestic market will be transitory is unwarranted. Because India is still under the pressure of El Nino, if it really occurs, inflation will continue to be above the tolerance level of the RBI in Q3. The Indian Ocean Dipole, which was positive last month has turned neutral. August month’s rainfall is forecast to be the driest since 1901. An increase in the heat level of the land will affect the yield production in 2023.
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The domestic market has undergone consolidation in the preceding month. While elevated CPI levels may have introduced some instability, the primary disruption arises from significant turmoil in the global currency market. DXY (the USD value index) has increased from sub-100 to 103.6, indicating an increase in the value of the dollar despite a downgrade in credit rating from AAA to AA+ by Standard & Poor’s rating agency. This paradoxical appreciation of the USD persists even amid a mounting fiscal deficit and economic frailty, inducing apprehension in the global market and arising tendency to move to safe haven assets like USD currency. FII outflow increased in the last month. However, selling in Indian equity is lower compared to other EMs. For example, FIIs total net inflow in India’s equites (Primary + Secondary market) continue to be positive at ₹8,400cr as per NSDL data. While heavy selling is noticed in other EMs like Taiwan, S. Korea and Indonesia this month.
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In its August policy statement, the RBI revised its forecast upward and acknowledged the potential for additional upside risks. At present, the RBI foresees a reduction in inflation from 6.2% to 5.7% in Q3. The FY24 CPI forecast has been increased by only 30 basis points to 5.4%. However, the factual data for July indicates a heightened risk beyond both market and RBI predictions. On a small note, the move to control liquidity through incremental CRR (to absorb the increase in deposits from the ban on ₹2000 notes) has impacted banking sector sentiment to some extent, yet the effects are expected to remain contained.
The significant setback lies in the projection that elevated inflation is set to endure over an extended duration, implying a prolonged period of elevated interest rates. Generally, high interest rates affect corporate earnings growth and valuation. However, the perspective is that India’s situation is poised for mitigation due to resilient domestic demand and the incremental influx of global orders fueled by China’s plus strategy. But invariably, high interest rate for a long time will have an impact on valuation. India’s one year forward P/E valuation has grounded in the last month from 20x to 18.5x.
Investors are exercising caution as bond yields make incremental gains. The strategy involves divesting equities and acquiring bonds. The US 10yr yield has increased to 4.3% from a low of 4.0% in the last month. Similarly, India’s 10yr yield has increased to 7.25% from 7.05%. However, the domestic market’s vulnerability is being buffered by restrained FII divestment compared to other EMs and robust purchasing by DIIs and retail participants. This trend aids in offsetting downside risks, contributing to the market’s superior performance.
Heightened divestment is notable in other EMs due to concerns related to deflation and the potential for defaults within China’s realty and finance sectors. Selling in US equities increased recently due to the downgrade of US mid-and small-sized banks. We can expect the selling from FIIs to continue in the short-term due to elevated global bond yields in developed countries, US devaluation (credit downgrade), and a slowdown in EMs, notably in China, potentially impacting EM’s performance. However, India will continue to outperform. In the last one-month MSCI World index is down by -4.2% compared to -1.85% by MSCI India.
The author, Vinod Nair, Head of Research at Geojit Financial Services
Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before taking any investment decisions.
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Updated: 20 Aug 2023, 10:49 AM IST
