Signal on inflation management makes strategists wary

The RBI's move on Tuesday left the equity investment strategist mindful of inflation-adjusted returns from the equity market.

“Nearly double-digit inflation does not inspire investor confidence. The RBI is likely to tilt the monetary policy more in favour of inflation management rather than growth. And it could be a prolonged affair. Hence, investors will have to be mindful of inflation-adjusted returns,” Mr Arindam Ghosh of Mirae Asset Management told Business Line . He also felt that investor would be forced extend the long-term horizon – from the usual one to three year timeframe to three to five years.

Investment advisors and market economists felt that going forward, higher inflation would erode equity returns further on Dalal Street. Lower-than-the-current GDP growth rate would not have done so much of damage, according to Mr Sunandan Chaudhri, the country economist at Espirito Santo Securities (ESS).

A study done by ESS suggested that a high inflation (five per cent plus) hammered down Sensex returns to zero. The effect on the BSE 200 and the BSE 500 were also found to be the same. The study further estimated that the influence of inflation of over 5 per cent was negative for the BSE Mid Cap Index, for the Small Cap Index and for the BSE 100. The Small Cap Index had the highest sensitivity towards inflation. If inflation is sub-five per cent, its rate of return is the highest among the BSE indices, whilst it is lowest if the inflation is above five per cent.

Mr Gul Tekchandani, an independent market strategist, felt investors now would turn to the Budget announcement for further clues. Mr Ghosh believed that actions of the Government in the coming days would be crucial for the investor fraternity, particularly for the overseas investors.

Analysts pointed out that the rising oil prices might further impact prices of both petroleum products and fertilisers. The RBI emphasised that if the Government chose to restrict the pass-through to consumers and farmers, it would have to make adequate budgetary provisions. This, however, would constrain its ability to reduce the fiscal deficit. If it did not raise the prices, it would be at the cost of reinforcement of inflationary expectations.

Ms Sonal Verma, economist at Nomura thought that the RBI suggested further rate actions.

“While we agree that GDP growth will moderate, we expect 8 per cent y-o-y in FY12 from 8.7 per cent in FY11, a moderation in inflation is contingent on food and global commodity prices not rising any further,” she said. In the near-term, risks to inflation had gone up, Nomura economist believed.

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