We all are aware of this common statement, “whatever goes up must come down”. However, the law of inflation, works differently. In this case, whatever goes up will go up some more. Stock markets hardly follow the law of inflation. Whenever inflation is mentioned, the markets promptly obey the law of gravity and fall. There is no doubt that inflation is an investors worst enemy. Equity investors lose as companies borrowing costs rise, credit becomes tight, and margins are squeezed. Debt investors see real rates (interest rate minus inflation) decline, and bond values fall. The non-investing public and politicians too, dread inflation. One can easily assume that rising inflation is a threat to the broad structural rally in Indian stock markets. Actually, its not possible to draw a close and direct connection between inflation and the sensex in the short term. Inflation will have an impact only over the long term.
Inflation is higher at the consumer level today. If inflation persists, it can be a threat. It will persist if prices move higher consistently or if expectations of inflation get baked into the economy. For example : In the first scenario, prices must keep rising and not just stay high, for inflation to persist. If they stayed high but stopped rising, inflation would drop to 0% after a year, because of the higher base effect. In the second scenario, people start demanding higher wages and prices due to inflationary expectations. This itself pushes up costs in the economy, giving inflation a leg up. In this case, inflation would persist for a few years, until expectations of inflation are controlled by policy action.
Keep a close eye on the dollar and Indian growth numbers, to get a sense of where inflation is headed in the coming year. The Indian growth rate, despite recent dips, is still healthy and can pick up again if RBI lets interest rates dip by the year end. If these things materialize, the current inflation monster we’ve so scared of will turn out to have been a mouse. Until then, learn to live with inflation. It’s not as bad as economists make it out to be. After all, that’s why you now live in a more expensive neighbourhood, without even moving.