Why inflation may become irrelevant for investors in March 2023

Why inflation may become irrelevant for investors in March 2023 – Mail Bonus

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For several decades, the world took inflation for granted. That’s because inflation has been under control for the last 40 years, giving central banks around the world a lot of comfort.

How It All Snowballed: In a Nutshell

Several factors helped keep inflation down for four decades. The main one was due to international integration. Developed economies began to source from China at competitive prices. China emerged as a manufacturing hub for the developed world. India provided cheap labor through BPO/KPO and IT services, while Ukraine and Russia served global energy needs. At the same time, in the developed world, the population began to age. With older adults tend to consume less and save more. It put a cap on demand in developed economies. But it wasn’t until Covid-19 came into the world that sudden changes occurred.

Supply constraints entered. The developed countries felt the pressure and started to apply China plus one policy. Crude oil prices, the biggest driver of inflation, began to rise significantly. All these changes happened simultaneously and quickly. If these had to come out individually, we would not have witnessed such an effect as we have seen in the world.

With inflation barely a thing for the past 40 years, central banks around the world suddenly felt the heat and had to take immediate action to curtail the surge. After several decades, the US Federal Reserve raised interest rates by 75 basis points in a row in 2 months: a feat not seen in the US in decades. In India, the RBI raised interest rates three times in 2022.

Is the worst behind us?

Now the question is whether the pain of inflation is over. Several economists and financial companies are divided on the issue.

Why is the world worried? Because inflation inhibits demand and reduces capital expenditure. The world economy is also facing recession. Hence, inflation concerns could exacerbate the situation further. But looking at the available data points, we think developed market inflation could continue for a while. This is because a developed economy will have to withstand higher energy prices. At the same time, a China plus one strategy means that their average purchase cost can rise as no other country can have the same economies of scale that China has.

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As far as India is concerned, we think inflation will come down. Why are we optimistic? While inflation has remained more or less stubborn in the US and other parts of the world, in India (for three consecutive months), CPI has come down. For example, inflation figures in May were lower than in April. In June it was less than in May and in July it was less than in June. Even wholesale inflation is falling.

So why do we believe inflation will come down for India?

Inflation increased primarily due to the increase in the price of crude oil and other metals. At the same time, the rupee weakened against the US dollar. Typically, when the rupee weakens against the dollar, it increases the cost of landing on Indian shores – as India is a net importer of crude oil and other commodities.

Fortunately, crude oil prices have started to fall and are now below $90 per barrel. The rupee also seems to have leveled off after falling to Rs 80 against the dollar. We believe that from this point onwards, there would not be much downward pressure on the rupee and it could probably start appreciating. We also believe that crude oil can go down to $80 per barrel. This would reduce the pressure on inflation. At the same time, metal prices such as copper, aluminum, steel, etc., have started to correct, which has helped reduce inflationary pressures.

The way forward

Persistent inflation may persist in developed market but not in India. What does this mean for inflation if it needs to cool down? RBI took an aggressive stance in raising interest rates. For example, we saw two 50 basis point rate hikes in the last two monetary policy sessions and the RBI may raise rates one last time. In other words, aggressive rate hikes from the RBI should not be expected in the coming months. Maybe in 2023 we should expect rate cuts from RBI. If that happens, based on our views, it could increase CAPEX and consumption volatility in the economy.

It makes us believe that the worst of inflation and the fear of interest rate hikes is in the rearview mirror. We are not saying that inflation will decrease immediately. Instead, the trajectory is likely to remain downward. I believe that by March 2023, inflation will not be a topic of discussion among equity investors.

(The author, Sunil Damania, is MarketsMojo’s Chief Investment Officer)

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