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A rate hike could be less than a year away, so cut exposure to leveraged companies

The notorious combination of falling growth and rising prices commonly referred to as a stagflation usually hamstrings central banks.

December 13, 2017 / 06:22 PM IST

Madhuchanda DeyMoneycontrol Research

Inflationary pressure in the economy wasn’t a surprise. But the shock came from the confluence of two weak macro data points – retail inflation (measured by Consumer Price Index) surging to 4.88 percent in November from 3.58 percent in the previous month, and anaemic industrial output, with the growth in Index of Industrial Production (IIP) decelerating to 2.2 percent in October from 4.1 percent in September.

The notorious combination of falling growth and rising prices commonly referred to as a stagflation usually hamstrings central banks. In analyst speak, it is a long pause. However, a deep dive into the data suggests that the pause could be punctuated by a rate hike even as early as calendar 2018. Equity investors should be positioned for such an outcome and reduce exposure to companies that have high leverage.

Inflation – the usual culprit
In the recently concluded Monetary Policy Committee meeting, the Reserve Bank of India was justifiably hawkish on inflation. Not only has CPI surged on the back of an across-the-board surge in food inflation; core inflation at 4.77 percent showed a sharp spike. We expect the inflation print to continue to remain firm until the middle of calendar 2018 (also due to the base effect) despite temporary relief coming from the arrival of new crops.

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The government has reached in excess of 96 percent of the fiscal deficit target already. It has up-fronted expenditure to revive growth and many state governments have announced a spate of loan waivers. Breaching the target would result in extra borrowing, which exert upward pressure on systemic rates.

Finally, global commodities maintain their bull run as the outlook for global growth remains firm.

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Growth – optically positive?

While growth continues to be weak, the sequential improvement in GDP in Q2 FY18 was comforting. While a part of the weakness in the Index of Industrial Production could be explained by the base effect, some nascent signs of revival were visible in capital goods, infrastructure and consumer non- durables. Thanks to the base effect, the Gross Value Added (GVA) in the second half of FY18 would look optically much better at 7.4 percent compared to 5.8 percent in the first half.

In fact, the credit growth data also seems to suggest nascent signs of cyclical recovery.

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What else is pointing to firming up of rates?Liquidity is tightening

3The gap between the 10-year G Sec yield and repo rate has only widened since the last rate cut in August 2017.

2Another data point that deserves attention is the falling deposits growth and the rising credit/deposit ratio.

1The falling deposits growth may be due to decline in the real rate of return on deposits as deposit rates have largely stagnated while inflation has gradually risen. For instance, the real return on one-year deposits has fallen from 3.5 percent last year to 1.9 percent now – a decline of close to 160 basis points.

As global central banks continue to ratchet up rates on signs of growth, the noise around a rate hike will only get louder amid these clear pointers in India. Equity investors should therefore re-examine the over-leveraged exposure in their portfolios.

For more research articles, visit our Moneycontrol Research Page

Madhuchanda Dey
Madhuchanda Dey
first published: Dec 13, 2017 06:11 pm

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