Inflation, rate cuts, falling markets: what now

The sharp outflow of foreign portfolio investor (FPI) money from Indian markets amid concerns over global growth, rising inflation and monetary tightening by central banks has accelerated the fall in equity markets.

Anticipating a spike in inflation in April, which came at 7.8%, the Sensex at the Bombay Stock Exchange fell by 1,158 points or 2.1% on Thursday to close at 52,930 — its lowest level since March 7 when it had closed at 52,842. The Sensex has lost 4,045 points, or 7%, over the last seven trading sessions as FPIs withdrew a net of Rs 23,670 crore since the Reserve Bank of India announced a surprise hike of 40 basis points in repo rates on May 4. Since October, FPIs have pulled out a net of Rs 1,86,089 crore.

In the same period that the Sensex has shed 7%, the Dow Jones Industrial in the United States too has lost 7% since the Federal Reserve hiked interest rates by 50 basis points on May 4. The Hang Seng in Hong Kong has lost 8.2%, the Nikkei in Japan 4%, and Dax in Germany 3.4%.

The concerns

Market sentiments have been negative for now amid apprehensions that the RBI could go for a series of rate hikes to keep inflation under check. The Fed has already hiked rates twice in the last two months, by 25 basis points in March and by 50 basis points last week.

A spike in interest rates will hurt not only consumption in the economy but also the margins of listed entities. If higher costs of raw materials will impact margins, higher interest rates will raise the cost of funds for companies, hurting their profitability in coming quarters.

As the April CPI inflation hit an eight-year high of 7.8%, the credit ratings agency CRISIL said in its report, “We expect the RBI to raise repo rates by another 75-100 bps in the rest of this fiscal. This move cannot bring down food or fuel inflation, but can help check its generalisation by curbing the second-round effects.”

A report by Kotak Institutional equities said that in 2022, from hereon, RBI could raise repo rate by 90-110 basis points. So, growth expectations are likely to moderate in line with the rate hikes, which will closely follow the inflation trajectory.

Where markets are headed

With central banks expecting inflation to remain elevated for some time, they are likely to continue with measures to keep it under check. With no end in sight yet to Russia’s war against Ukraine, the geopolitical situation will continue to hurt global economies and equity markets. Further rate hikes will push FPIs to move out of emerging economies, which will have a bearing on these markets and their currencies. So, with the markets likely to remain under pressure, investors will have to wait and see how the inflation situation pans out over the next few months.

However, even as the markets fall, investors should take the cue from what domestic institutional investors (DIIs) have been doing. In May, while FPIs have pulled out a net of around Rs 25,000 crore from Indian equities, DIIs have invested a net of Rs 23,565 crore. And since October 2021, against a net FPI outflow of Rs 1.86 lakh crore, DIIs have invested 2.24 lakh crore.

So, retail investors can go for long-term value investing as net asset values have fallen and several blue-chip stocks are trading at a significant discount. Investors need to be cautious and go for high-quality companies, and should put in their money only if they can remain invested for 3-5 years.

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