Vijay Kumar Gaba

From the Bollywood movie ‘Chak De India’ (Dir. Shimit Amin, 2007), the climax sequence has been particularly popular. It is perhaps one of the most popular, inspiring, and quoted pieces of Indian cinema. In one part of the climax, the protagonist (played by Shah Rukh Khan), who is the coach of the Indian national women’s hockey team, is guiding the team in the World Cup final match against the defending champion Australia. During a penalty shootout, the coach tries to anticipate the penalty shot of the Australian striker by reading her body language – leg position, eyes, hockey stick and wrist position etc. – and correctly concludes that the striker will hit the ball straight and guides the Indian goalkeeper to stay still in the middle of the goal post. The goalkeeper saves the critical penalty and India wins the match.

 One of the most common narratives in all the investment advisory pitches is the impact of inflation on investors’ wealth. Inflation is often termed as termite that silently destroys investors’ wealth. Protecting wealth from inflation is therefore one of the primary objectives of almost every investment strategy.

Over the weekend I examined more than twenty-five investment proposals, mostly focusing on elevated inflation and its impact on real returns. The common advice is to take higher risk by increasing the proportion of high yielding debt and equities.

Discussions with investment advisors indicate the investment strategies aimed at protecting the real (inflation adjusted) value of the investors’ portfolios may be based on poor, and often wrong, understanding of the impact of inflation on investors. Most of them presented the official data of inflation and suggested investment products that may yield a return that is higher than the official CPI (Consumer Price Index) inflation.

None of the 20 odd investment advisors I spoke with has considered that inflation is a very personal phenomenon. Every investor may have a different inflation number to deal with. The official CPI inflation may be of little relevance for a majority of household investors. The inflation affects rural and urban investors differently. The inflation also varies according to the State, an investor lives in and incurs most of the expenditure. The impact of inflation on investors’ wealth could be different depending on his consumption pattern and saving propensity.

·         The inflation rates for various states are different. In March 2023, West Bengal CPI inflation was just 4%, as compared to national average of well over 5% and Tamil Nadu inflation of 7%. Investment strategy for investors living in Kolkata and Chennai need to account for this difference.

·         The weightage of different states in calculation of CPI is also different. Maharashtra has a weightage of 13% (8% rural and 19% urban) in overall CPI basket; while Bihar has a weightage of 5%. Obviously, the investors in Patna and Mumbai face different inflationary impact; and their investment strategies to fight inflation need to be different.

·         The weightage of food and beverages in rural CPI basket is 54%, while in urban basket it is 36%. The combined basket has a weight of 46% for food. Obviously, food inflation impacts rural and urban investors differently. Rural basket has 3% weightage for Pan, tobacco and other intoxicants while urban basket has a weight of 1% for this. Similarly, the weightage of education, health and dairy consumption also varies sharply for rural and urban consumers.

·         The official CPI basket does not account for the inflation in housing and rental cost, which could be a significant expenditure for many investors, especially in urban areas.

·         One of the most important aspects of inflation consideration in investment strategy should be the saving propensity of the investor. An investor which is able to save 60-70% of his income cannot be put n the same bracket as an investor who saves just 10-20% of his income.

·         The investors who have significant debt and use most of their savings to repay the debt may have a self-neutralizing inflation. Similarly, an investor engaged in a money lending business might be much more severely impacted by inflation than investors who have significant borrowing.

·         A 70yr old investor with independent children, who consumes less cereals, education and transportation and more healthcare will have very different inflation impact as compared to a 40yr old investor with school going children and dependent aged parents will have remarkably different consumption basket and therefore inflation impact.

The point is that the impact of inflation is usually different for various investors depending on their individual circumstances and status. Therefore, investment strategy needs to be personalized for all investors, or at least class of investors. Selling the fear of inflation and making them invest in products which are benchmarked to official CPI may not serve much useful purpose for most of them.

Investors also need to understand their inflation profile and accordingly adjust their investment strategy.

         

 In the current year 2022, inflation in India has consistently remained above the RBI tolerance band of 2-6%. For the month of August Consumer Price Inflation (CPI) was 7%, led primarily by the food inflation of 7.6%. Both rural and urban inflation recorded a MoM rise in August. Unfavourable weather conditions apparently led to sharp rise in the prices of vegetables, fruits, spices etc. However, the core inflation (CPI ex food and fuel) has also persisted over 6% since the past many months; emphasizing the persistent pricing pressures. The IIP growth in July also moderated to 2.4% led primarily by consumer non-durables – indicating pressure on household finances. The sharp rise in household debt, especially the expensive credit card rolling credits, also corroborates the rising stress on household finances.

In view of the elevated price pressures, the Monetary Policy Committee (MPC) of RBI is expected to keep raising rates in line with the global peers. The market consensus is expecting the policy repo rate to rise to 6% (currently 5.40%) by the end of 2022. In his latest statement, the RBI governor stated that he does not expect moderate hikes in policy rates and elevated prices to hurt the growth materially and the economy may still retain the momentum to grow 7% in FY23.

The RBI estimate of growth may be optimistic in view of the poor Kharif crop estimates; challenges to exports; rising interest cost and poor consumption growth outlook. The risk of a global energy crisis in winter is also looming large and could have some negative implications for our inflation and growth outlook.

Inarguably, the claim of the finance minister that India faces zero chance of a recession is tenable. But a growth of 5-6% on a low base would be nothing to celebrate in our circumstances.

Obviously, the financial markets are disregarding the macroeconomic conditions and focusing on micro opportunities, especially the ones driven by policy impetus. In particular the following are some identifiable drivers of the stock markets in the recent up move.

1.    Strong emphasis on enhancing local defence procurement, especially in view of the global sanctions on our largest supplier (Russia) and elevated Chinese threat. The global sanctions on Russia have also presented an opportunity to Indian manufacturers to gain some foothold in global defence equipment and missiles markets; where the efforts of Indian entities, made in the past many decades, have started yielding results. The stocks of the companies that could be potential gainers from higher local defence procurement are favourites of investors as well as traders.

2.    Realignment of global supply chains in the post Covid world is expected to trigger a new capex cycle in Indian manufacturing sector. The potential beneficiaries of this capex cycle like capital goods manufacturers are also gaining traction with market participants.

3.    The most favourite sector in Indian markets is the financial sector. The cleaned up balance sheets after years of efforts and increased margins as the rate cycle turns up are attracting massive investor interest to the sector.

4.    The energy crisis in Europe and the US is also creating opportunities in Indian markets. For example, prohibitively higher energy cost has rendered significant industrial capacities (especially in high energy consuming sectors like chemicals) unviable. Closure of these capacities is allowing some Indian manufacturers to gain market share as well as better pricing power.

5.    The trends in energy security and climate control (green energy, electric mobility etc.) are also leading greater investor interest in the related businesses.

6.    Given the poor growth outlook in Europe and China, the FPI flows have turned towards emerging markets like India. Significant positive flows over the past couple of months have also helped Indian equities to outperform its global peers.

It seems the divergence between the equity market performance and macroeconomic conditions may continue or even widen in the short term. However, over a longer period, say 12-15 months, both invariably converge. Till then its happy times for the investors and traders.

 The macro economic data released last week produced further evidence of the Indian economy struggling with stagflationary conditions; notwithstanding the denial by various authorities.

Inflation impact widening and deepening

The consumer price inflation date for the month of April 2022 was a negative surprise. The consumer prices escalated at a rate of 7.8% (yoy) during the month. The higher inflation was, to a large extent, a consequence of imported inflation which added almost 2% to the headline inflation number. Though, the inflation due to rise in domestic prices at 6.4% was also no comfort.

With worsening current account (and depreciating INR); continuing supply chain disruptions; protracting Russia-Ukraine conflict; extreme weather conditions and tight fiscal conditions (little chance of duty cuts) and rising cost of capital – it is unlikely that we shall see any material easing in prices in the next few months; even though the headline inflation number begins to ease from October 2022 due to statistical reasons, as the high base kick in.

Contracting consumer demand constricting the growth

On the other hand, the recent data about the growth in Industrial Production raised many red flags. The IIP growth for 4QFY22 has come at a dismal 1.6% (vs 2.1% in 3QFY22).

The consumer goods production (both durable and non-durable) contracted 4.3% in March 2022, recording its sixth consecutive decline. This clearly shows the stress in the consumer demand. Growth in capital goods was a poor 0.7%. Manufacturing growth in March was also poor at 0.9% yoy. 

Normalizing for the sharp dip in 2020 due to the pandemic induced lockdown and subsequent sharp spike in 2021, India’s Industrial Production has been dismal in the past decade.

Poor suffering the most

Notwithstanding the claims of some politicians, the poor seem to be hurt most by the rising inflation and slower growth. As per the latest NSO data, the inflation rate is much higher in most populous states like West Bengal (9.1%), Madhya Pradesh (9.1%), Maharashtra (8.8%), Uttar Pradesh (8.5%0, Odisha (8.1%0 and Rajasthan (8.1%). These states may be home to a large proportion of the poor population in the country.

Kerala (5.1%) and Tamil Nadu (5.4%) are suffering relatively much lower inflation.

Besides, the real interest rates have fallen deep into negative territory in the past couple of years, as monetary stimulus to mitigate the pandemic effects has brought the rates lower while inflation has stayed high. Obviously the poor savers and pensioners who rely on meager interest income for survival are suffering a great deal.

 As per the latest survey conducted by RBI, the Consumer Confidence in India remained at an all-time low level in September with the general economic situation worsening during the month. This data read with the dismal IIP growth (-8%) and elevated consumer inflation (7.34% highest since January 2020) indicates that (i) the recovery from lockdown is slower and belies the enthusiasm shown by some of the analysts and economists; and (ii) we shall struggle to reach the pre lockdown level of economic activity for at least 2 more quarters and any improvement in the growth trajectory normalized for lockdown impact may still be far away. Remember, the economic growth in India was declining much before the pandemic forced a complete lockdown in March 2020.

The key highlights of the Consumer Confidence Survey (September 2020) are as follows:

·         As per the survey, the consumer confidence (current situation) continued to slip for third successive month and is presently at all time low. Presently, the respondents perceive further worsening in general economic situation and employment scenario during the last one year. Though some improvement is expected a year later.

·         21% respondents reported curtailment in overall spending during the past one year, when compared with the last survey round. While 59.8% reported cut in non-essential spending.

·         Even though consumers expect improvements in general economic situation, employment conditions and income scenario during the coming year; the discretionary spending is however expected to remain low in the near future.

·         Households’ median inflation expectations remained elevated for both three months and one year ahead periods.

83% households reported rise in cost of living. 75.9% expect cost of living to rise further in next 12 months.

An astounding 81.7% household reported worsening of employment expectations in past one year. Though, 54.1% respondents hope that the employment conditions will improve in next one year. A significant 36.1% of respondents believe the employment conditions will worsen in next 12 months.

·         62.7% household indicated lower income in past one year; while only 8.9% reported higher income. 53.2% household expect income to rise in next one year, while 10% expect it to decrease further. Overall, 79.6% respondents felt that general economic conditions have worsened in past one year; while 34.8% respondents continue to believe that the conditions will worsen further in next 12 months. Only about 50% respondents believe the conditions to improve in next 12 months