Do it yourself

The rate of Consumer Price Inflation (CPI) in India dropped to 3.34% in the month of March; below the lower bound (4%) of the regulator’s (RBI) target band of 4% to 6%. It is definitely a significant development insofar as the monetary policy consideration, macroeconomic stability, and consumer confidence are concerned.

If this trend sustains, it would pave the path for further easing in the monetary policy; improve the fiscal outlook; improve the outlook for debt and currency markets; aid corporate profitability and encourage fresh investment flows. In this sense, it is certainly good news for the investors in Indian financial markets in the near-term.

However, in my view, a low inflation rate does not help a large section of the Indian population much. A low inflation rate only implies a slower rise in the price level as compared to the prices in the base period. It offers no relief to the people who are already finding the existing prices of the essential goods and services unaffordable. A slower rise, not matched by a similar rise in wage level, just makes the living conditions even more challenging.

Apples at Rs300/kg and Mangoes @Rs180/kg are unaffordable for many middle-class households, even though their annual inflation rate may be close to zero.

Over the past two decades, nominal wage growth has often lagged or barely matched CPI inflation, especially for informal and unskilled workers. This has led to stagnant or declining real wages, exacerbating affordability challenges.

This trend, juxtaposed with poor new job creation, implies a further squeeze on the struggling middle class of India. The growth rate of private consumption, which constitutes approximately 60% of India’s GDP, will decelerate. Household savings which have cushioned the fiscal balance since independence, will erode even faster. A significant section of middle-class households may slither into a debt trap. Investment rate will deteriorate. The economy will get stuck in a vicious cycle of poor savings rate-low investment rate-lower economic growth-lower household income growth-poor savings rate.

Wage dynamics in India

As per the latest Annual Report (2023-24) of the periodic Labour Force Survey (PLFS):

·         Labour Force Participation Rate (Ratio of workers employed and willing to work to the total population) in India is ~46%. The worker population ratio (WPR) is slightly lower at ~43%.

·         Of the total Worker population (WP), 58% workers are self-employed (39% work on their own account and 19% family members helping these own account workers). Only 22% of WP is employed in a regular salaried job. ~20% of WP is casual workers.

·         Regular wage workers (22% of WP) earn on average Rs700/day wage. Self employed workers earn on an average Rs463/day wage. Casual workers earn on an average Rs433/day wage.

·         About 90% of WP is employed in the informal sector, with mostly undefined social security and poor job guarantee.

·         Job creation has been a persistent challenge. The PLFS data shows unemployment rates hovering around 6–8% from 2017–2023, with youth unemployment (15–29 years) exceeding 15%. Formal job growth has been sluggish, with only ~10% of the workforce in organized sectors. The IT and services sectors, traditional middle-class job engines, face slowdowns due to automation and global competition.

·         In the past decade or so, wages of the regular salaried employees have risen at 3.7% CAGR; while casual and self-employed have experienced 2-3% CAGR in their earnings. CPI index in the 2013-2025 period has risen at 5.5% CAGR. The affordability quotient of middle classes has obviously diminished.

It is pertinent to note that “Nominal wages grew faster (6–10%) in the 2000s due to MGNREGA and economic growth but slowed to 2–4% post-2015, lagging inflation.

Implications of diminishing affordability quotient

The combination of stagnant real wages and poor job creation has put a squeeze on middle-class disposable income, reducing their ability to consume and save. This is particularly acute for the lower middle class, who lack the financial cushion of wealthier households.

·         Private Final Consumption Expenditure (PFCE) accounts for ~60% of India’s GDP. PFCE registered a growth rate of 6–7% in the 2000s and early 2010s. In the past five years PFCE growth rate has slowed to 4–5% due to economic shocks like demonetization, GST implementation, and the COVID-19 pandemic. Recent trends are indicating a recovery in consumption, with PFCE growth projected at 5–6% for FY25, driven by rural demand and government transfers. However, urban middle-class consumption continues to remain subdued.

Stagnant real incomes and high absolute prices (e.g., food, fuel, education) have adversely affected the discretionary consumption (e.g., durable goods, travel) of households. For example, automobile sales, a proxy for middle-class spending, grew only 2–3% annually post-COVID, reflecting affordability challenges.

·         Household savings have been quintessential to India’s fiscal stability, financing investment, fiscal deficit and cushioning the current account deficit. Gross household savings averaged 20–25% of GDP in the 2000s but have since declined to 17–19%. Financial savings (e.g., bank deposits, mutual funds) have fallen from 10–12% of GDP in the early 2010s to ~7% in 2022–2023.

A sustained decline in household savings reduces the pool of domestic capital available for investment, increasing reliance on foreign inflows or government borrowing. This is straining India’s fiscal balance and public investment. Erosion of savings is also making middle-class households vulnerable to economic shocks.

·         Household debt in India has risen steadily, from ~10% of GDP in the early 2000s to 40% by 2023. Retail loans (e.g., housing, personal, credit card debt) grew at 15–20% annually post-2015, far outpacing income growth. Middle-class households are increasingly relying on debt for housing, education, and consumption (e.g., EMIs for durables).

If real incomes stagnate and job creation lags, households may struggle to service debt, especially with rising interest rates. A debt trap would further erode savings, reduce consumption, and increase financial instability, as households divert income to debt repayment. This could also strain the banking sector, reducing credit availability for investment.

·         Gross Fixed Capital Formation (GFCF), a measure of investment, averaged 30–32% of GDP in the 2000s and has fallen below 30% by 2024. In particular, corporate capex has remained slow, despite a variety of government incentives. Declining household savings has on one hand reduced the available domestic capital pool for investment; while on the other hand poor demand growth visibility is also discouraging new capacity building in many areas.

·         Declining household savings has adversely affected bank deposits, constraining credit for small and medium enterprises (SMEs), a key investment driver. RBI data shows SME credit growth slowing to 10–12% from a high of 18-20%.

Conclusion

While low CPI is welcome, it does not address affordability issues. It is critical to not lose focus on managing the price situation and improve the affordability quotient of households. The urgency of implementing structural reforms cannot be emphasized more at this point in time.

Massive efforts and pragmatism are needed in the areas of agricultural productivity enhancements, education & skilling of workers, improving women workforce participation rate, making education, housing and healthcare costs affordable for households. A strong wage indexation mechanism could also help improve the affordability quotient. 

The 3-day bi-monthly meeting of the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) begins today. This would be the last meeting before presentation of the Union Budget for the year FY26. The members of the MPC would draw inputs from the latest national accounts (2QFY25 GDP data); October 2024 inflation data; October 2024 Professional managers’ survey results; September 2024 IIP estimates; November 2024 PMI and core sector growth data; April-October fiscal balance data; global developments (political and geopolitical); global inflation, rates, currency and market trends; expert opinions and views of the members of MPC; and assessment of the current and future situation provided by the staff of RBI.

The statement of the MPC on macroeconomic outlook and likely direction of the monetary policy will be a key input in preparation of the Union Budget for FY26. However, the market participants’ interest in the MPC meeting appears limited to whether, or not, at 10AM on 6^th December 2024, the RBI governor announces a repo rate cut and/or a cut in the cash reserve ratio (CRR). Some TV show panelists might also bother to note the downward revision, if any, in the growth estimates for FY25.

If the MPC decides to maintain a status quo on its policy stance – considering growth slowdown a temporary blip expecting a recovery from 3QFY25; and continue to accord higher weightage to still elevated inflation and highly uncertain and volatile global conditions, the market participants may be hugely disappointed.

Not to cut: In the October policy statement, the governor had adequately hinted about its preference for price stability over growth (see here). Perhaps RBI is much more conscious about the looming external threats, especially the balance of payment situation if there are sudden FPI outflows; or the FDI flows get restricted; or remittances are affected.

Or to cut: In the recent weeks, RBI has allowed USDINR to sustainably breach 84 mark. It appears that it may want USDINR to weaken further before Trump takes over the US presidency on 20^th January, and urges its trade-surplus trade partners to strengthen their currencies. We have seen a similar weakness in USDCNY also, for example. A token 25bps or an aggressive 50bps rate cut could drive USDINR to 86 in near term, providing RBI a leverage to engineer a ~5% USDINR appreciation to ~83 level in the next three months.

In either case, the transmission of the lower rates may not be in the corresponding measure, as RBI might continue to control credit growth and liquidity to reign inflation, asset quality and excessive unsecured lending. I therefore would not expect a CRR cut. I am however mindful that the market is pregnant with the hope of a CRR and/or repo rate cut and no action in this regard may lead to a sharp sell-off in financial stocks, especially NBFCs.

The market participants may also take note of the following three potential near term risks:

·         Besides the real GDP growth, the nominal GDP growth has also fallen to 9% in the 2QFY25. A lower nominal GDP growth directly impacts the tax collections and corporate profitability. November manufacturing PMI is at 11 months low. Core sector growth has also been low in 3QFY25. Expecting an immediate revival of growth in 3QFY25 may not be prudent; and the RBI may not mind a transitory higher inflation to boost nominal GDP growth.

·         The president-elect Trump has explicitly threatened the BRICS nations to refrain from any misadventure that would impact supremacy of USD. It may purely be rhetorical to gain some upper-hand in trade/sanctions negotiation with Xi and Putin. Nonetheless, it could cause higher volatility in the global markets. It becomes critical given that BRICS members supply two thirds of global fossil fuels.

·         The outgoing president Biden has provided a complete pardon to his son, who was facing multiple criminal charges in the US. Biden had earlier categorically denied this favor to his son. Experts are interpreting this as an indication of rising fear of a widespread witch hunt by the Trump administration. The witch-hunt, if it does take place, may not remain restricted to the domestic political opponents of Trump. 

The Consumer Price Index (CPI) inflation for the month of July came at 3.54%, the lowest in five years and below the RBI tolerance band of 4-6%. This has excited some market participants as their hopes of an earlier rate cut by RBI have been rekindled.

I am however not sensing any imminent rate cut, for the following simple reasons.

(i)      The headline inflation number is significantly impacted by a strong base effect, as the CPI inflation in the base period (July 2023) was 7.4%. Sequentially, the inflation has risen 1.42% MoM in July 2024 against 1.33% MoM rise in June 2024. As of now, there is no indication of a sustainable decline in inflation trajectory.

(ii)     Core CPI inflation in July 2024 was 3.3% against 3.1% in the preceding two months. This is the first rise in core CPI after twelve months of consistent decline.

(iii)   Food inflation remained sticky, rising 2.47% in July 2024 after a 2.69% rise in June 2024. Vegetable prices were higher by 14% MoM in July 2024. It is pertinent to recall that the RBI governor laid significant emphasis on food inflation in his bi-monthly monetary policy statement.

The governor stated, “our target is the headline inflation wherein food inflation has a weight of about 46 per cent. With this high share of food in the consumption basket, food inflation pressures cannot be ignored. Further, the public at large understands inflation more in terms of food inflation than the other components of headline inflation. Therefore, we cannot and should not become complacent merely because core inflation has fallen considerably”.

He further added, “high food inflation adversely affects household inflation expectations, which have a significant impact on future trajectory of inflation. Household inflation expectations, after witnessing a moderating trend between May 2022 and September 2023, have edged up on the back of high food inflation since November 2023.35 Persistently high food inflation and unanchored inflation expectations – if they materialise – could lead to spillovers to core inflation through pick-up in wages on cost-of-living considerations. This, in turn, could be passed on by firms in the form of higher prices for services as well as goods, especially in a scenario of strong aggregate demand. Third, these behavioural changes can then result in overall inflation becoming sticky, even after food inflation recedes.”

He categorically admitted that “The MPC may look through high food inflation if it is transitory; but in an environment of persisting high food inflation, as we are experiencing now, the MPC cannot afford to do so. It has to remain vigilant to prevent spillovers or second round effects from persistent food inflation and preserve the gains made so far in monetary policy credibility.”

(iv)    As per the latest Households’ Inflation Expectation Survey (August 2024), A larger share of households expects higher general prices and inflation as compared to the previous survey round. Households’ median perception of current inflation rose by 20bps to 8.2% in the latest survey round; their inflation expectations for the three months and one year ahead periods also increased by 20bps each.

The market trends in August indicate that vegetable prices have recorded material rise in the month of August also due to crop damage by excess rains and logistic issues. It is therefor likely that August food inflation may come even higher. Expecting any rate cut on 9^th October may therefore not be reasonable; unless the US Fed cuts dramatically in September, raising the
specter of recession.

 

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