How does the recent decline in India’s retail inflation to an 18-month low impact investing in the Indian market?
Excellent question. The recent decline in India’s retail inflation to an 18-month low of 4.7% in April can indeed impact the investing landscape in interesting ways. Let’s break it down.
Firstly, lower inflation can be seen as a positive sign for equities. The reason is that lower inflation often translates into reduced input costs for businesses. For instance, if we look at sectors like manufacturing or FMCG where raw material costs are significant, a drop in inflation can result in reduced raw material costs. This could potentially enhance the profitability of companies in these sectors. For example, if a manufacturing company was spending 30% of its revenue on raw materials and the inflation drops by 1%, the company’s profit margin could increase substantially, which could reflect positively on the stock price.
Secondly, this inflation figure falls within the Reserve Bank of India’s (RBI) target range of 2-6%. When inflation is within the central bank’s comfort zone, it reduces the pressure on RBI to hike interest rates. Higher interest rates can increase the cost of borrowing for companies, potentially hurting their profitability. This also makes bonds more attractive relative to stocks due to the higher yields, potentially causing a shift of capital from equities to bonds. However, with inflation in check, the RBI is less likely to raise rates, which could be positive for the stock market.
Moreover, the reduced inflation rate can impact sectors differently. For instance, in the case of the real estate sector, a lower inflation rate can potentially reduce the cost of construction materials, which could help real estate developers to increase their margins.