Universal Stagflation

Markets corrected sharply over the last fortnight as higher interest rates & inflation globally have led to fears of stagflation. Stagflation refers to an economy that has inflation, a slow or stagnant economic growth rate, and a relatively high unemployment rate. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.

FII have been selling heavily in Indian equities in FY22 to the tune of Rs.2.75 lakh cr. They have continued to be net sellers to the tune of Rs.40652 cr in April & Rs.34489 cr MTD till 16^th May 2022. At a time when FIIs have continuously been selling, DIIs have provided some support to the markets. With interest rates & bond yields increase globally & Ukraine-Russia conflict continuing we are seeing asset re-allocation towards USD & US bonds.

Despite weakness in the financial markets, the Indian mutual fund industry has seen a good start to the new financial year at it witnessed net inflows of Rs.72847 cr during the month of April, as per data released by the AMFI. However, monthly systematic investment plan (SIP) contribution at Rs.11863 cr in April 2022, stood Rs.464 cr lower m-o-m. Overall, at Rs.38.03 lakh cr, net assets under management (AUM) of the Indian mutual fund Industry as on 30^th April, stood at an all-time high, a 17% growth y-o-y. The new flows for debt oriented schemes stood at Rs.54756 cr.

Gold price have been declining for some time now as gold declined to ~$1810/oz in international markets & ~50000 in India. Gold may witness some softness at current levels. Higher inflation and geopolitical volatility are supporting gold prices but various physical tightening measures by central banks to curb inflation and stronger dollar are pushing gold to lower levels. INR has been depreciating sharply against the USD and has been hitting all-time highs around Rs.78/$.

Brent crude prices remained range bound between $103-$115/bbl. The lingering Ukraine Russia conflict & decline in Russian oil exports have kept crude at elevated levels. U.S. gasoline futures are at all-time highs as falling stockpiles fuelled supply concerns. Stockpiles in the Strategic Petroleum Reserve fell to 538 mn barrels, the lowest since 1987, data from the U.S. Department of Energy showed. Optimism that China would see significant demand recovery after positive signs that the country’s coronavirus pandemic was receding in the hardest-hit areas is further pushing up crude prices.

Inflation in US is at a 40 years high and crude at elevated levels will aggravate the problem. The US Federal Reserve on 6^th May raised the benchmark lending rate by 50 bps, in what is being viewed as the sharpest increase in over two decades. Further rate hikes are on the anvil. The Fed also announced that it will start reducing its huge $9 trillion balance sheet, which consists mainly of treasury and mortgage bonds. Hiring is strong, layoffs are few, unemployment is near a five-decade low and the number of job openings has reached a record high.

Consumer Price Index inflation (CPI) surged to a near 8-year high of 7.79% in April, persisting above the RBI’s inflation target for the fourth straight month. The food price inflation surged to a 17-month high of 8.38% in April from 7.68% in March. Core inflation — the non-food, non-fuel component of inflation — in April also touched a 95-month high of 6.97%, remaining more than 5% for 24 consecutive months.

Wholesale Price Index (WPI) rose further to 15.08% in April from 14.55% in March a double digit print for thirteenth consecutive month. The inflation print for April is the highest in the current series, data for which is available starting April 2013. In what will leave policymakers worried, the food index posted the highest sequential gain in April, rising 3.4% m-o-m.

The RBI in an unscheduled meeting on 4^th May hiked the benchmark lending rates by 40 bps, along with a 50 bps hike in the cash reserve ratio (CRR), signaling a hawkish tilt to its policy. This was the first rate action by RBI since May 2020. Against the continued increase in inflation, and rupee depreciation, it is now almost certain that RBI will raise rates in forthcoming June and August policy and will take it to the pre-pandemic level of 5.15% by August. A higher interest rate will be also positive for the financial system as risks will get re priced.

The Index of Industrial Production (IIP) has grown a lackluster 1.9% y-o-y in March, pulled down by an unfavorable base effect and price rise. Industrial production had grown 1.7% in February as well. The manufacturing sector’s output grew 0.9% in March 2022. Mining output climbed 4%, and power generation increased 6.1%.

The S&P Global India Manufacturing Purchasing Managers’ Index (PMI) rose from 54 in March to 54.7 in April. This comes as relaxation in Covid restrictions continued to support demand. The April PMI data pointed to an improvement in overall operating conditions for the 10th straight month. Services Purchasing Managers’ Index (PMI) rose to 57.9 in April from 53.6 in March, making up for the loss since the Omicron variant of coronavirus hit the country in late December. Composite PMI Output Index — which measures combined services and manufacturing output — rose from 54.3 in March to 57.6 in April, highlighting the quickest pace of growth in five months.

The IMD said that the moisture laden south west monsoon winds, which is extremely crucial for the agriculture based economy of India has advanced towards Andaman and Nicobar islands. The IMD, in its latest weather forecast, has predicted that the monsoons are expected to arrive early in the country in 2022. The weather department had predicted normal rainfall during the four month long monsoon season this year.

As per Society of Indian Automobile Manufacturers (SIAM) the total number of Passenger Vehicles (PVs) sold in India in April 2022 stands below April 2017 levels. Passenger vehicles were down 3.8% to 251,581 units. Two-wheeler sales increased 15.4% to 1,148,696 units on the low base of last year when April 2021 was marred by the 2nd covid wave. Three-wheeler sales for the industry grew 51.1% to 20,938 units in April 2022. CV sales in April stood at 78,398 units, up 52.18% y-o-y. The recent interest rate hike would increase lending rates and what impact it has on demand needs to be seen.

Gross GST collections hit an all-time high of Rs.1.68 lakh crore in April, indicating strong economic activity despite multiple headwinds and better tax compliance. The April number is up 20% from the year earlier and ~Rs.24,000 cr more than the previous highest of Rs.1.42 lakh cr in March this year. The all-time high magnitude of inflows is very enthusing, and augurs well for a robust growth in the months ahead as well. Of the total, central GST amounted to Rs.33,159 cr, state GST was Rs.41,793 cr, integrated GST was Rs.81,939 cr while Rs.36,705 cr was collected on import of goods.

Morgan Stanley has lowered its forecasts for India’s economic growth in the next two fiscal years, saying a global slowdown, surging oil prices and weak domestic demand would take a toll on Asia’s third-largest economy. Gross domestic product growth will be 7.6% for fiscal 2023 and 6.7% for fiscal 2024, 30bps lower than the previous estimates. India’s FY23 GDP is expected to grow between 7.4 and 8.2% as per CII. India meets nearly 80% of its oil needs through imports and rising crude prices push up the country’s trade and current account deficit while also hurting the rupee and fuelling imported inflation.

Q4 results have mostly been disappointing on account of high expectations. High raw material costs have compressed margins & profitability. But even then current Nifty 50 is trading at a trailing P/E ~19x, forward 15-16x P/E. So per se NIFTY is not very expensive. A 5-10% fall in markets is always possible, but a crash looks unlikely as we will have strong earnings support. There was a lot of focus on the LIC IPO & it had a tepid listing marginally below issue price.

Globally high inflation, rising interest rates coupled with a slowdown is worrying as there are fears of stagflation.  The frontline indexes have corrected sharply below 16000 NIFTY, we feel proper stock picking will be critical. We are in the middle of Q4 earnings season & results have been below expectations. The LIC IPO had a tepid listing marginally below IPO price. GST collections have increased to over Rs.1.6 lakh cr/month and whether it sustains at current levels needs to be seen. IIP numbers have been low and need to pick up. High inflation along with high fuel prices remain a concern. With crude above $100/bbl further rise in inflation is possible. With the FED increasing rates continuously & inflation on the rise in India, we expect RBI to also increase rates. We strongly advise investors to continue their SIPs in equity funds & if possible increase the amount. This is a very good buy on dips market & should be bought in a staggered manner.

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Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 14 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata.