In our earlier blog post, we learnt how there may be a possible end to the bull run in Indian stock market, due to reasons including global macroeconomic factors. In today’s blog post, we will try to understand why and how the US inflation affects the Indian stock market.
The Demand-pull Inflation
Inflation rate of an economy is an indicator of ever-rising consumer prices over a specific period of time. The US inflation was due to the aggregate demand in the economy strongly outweighing the aggregate supply, resulting in price hike.
Post COVID-19 pandemic, factors weakening supply-side included but were not limited to, inadequate supply, shifting consumer demands, increasing cost of labor, and rising oil and gas prices.
On the other side, lower borrowing rates and a beyond-estimates economic recovery contributed in creating a strong demand. Thus, the shortage of supply and heavy demand side caused demand-pull inflation.
Too Hot to Handle?
As per the data released by the US Bureau of Labor Statistics in February 2022, the US inflation rate climbed to 7.90% over the past year, a record high which hit a fresh 40-year peak since January 1982. It posed a big concern particularly when the inflation rate should be 2% for a developed economy like US as against the country’s GDP growth rate of 3-4%.
While the economy was already experiencing inflation, adding fuel to the problem was the possibility of the US and European countries banning the Russian Oil imports, and due to fear of shortage, the Crude Oil prices in the US touched $139 a barrel. Moreover, predictions suggested the oil prices could easily cross $200 a barrel mark in near future if the US decides to join the war! As a cascading effect, the food costs, energy bills, fuel costs, commodities were already skyrocketing.
Thus, the US inflation rate went through the roof as it surpassed the Street’s expectations.
Attempts to Tame Inflation
The US Federal Reserve, in its balancing act, plans to impose a massive interest rate hike, which will be implemented gradually. It was predicted that the Federal Reserve may take aggressive stance through its monetary policies and may impose a single large rate-hike. The US stock markets feared more interest rate hikes will be seen through this year, as by December 2022, the Federal Reserve said it plans to increase interest rates by upto 1.90-2%.
Why Interest Rate Hike Hurts
Repo rate hike hurts a company as apart from share capital, it funds its business by raising debt – sometimes debt portion is so huge, any increase in the interest rates (even 25 basis points) means increase in interest cost of debt, which in turn hurts the profit margins.
A Slow Remedy
Despite the Fed rate hikes, it’s going to take a while for its effect to seep into the economy and tame the inflation. The stock markets do not perform in economic uncertainties, as the aggressive Fed policies also need complementing government reforms.
Just like Inflation, its remedial measures too, are slow pacers. The effect doesn’t show overnight.
Impact on Indian Stock Market
From Indian stock market’s perspective, US inflation at 7.90% may not sound too alarming. However, during 2008-09 global economic crisis, Indian economy experienced 12.31% inflation. So yes, a record-high inflation in the US may mean trouble for Indian economy even this time.
Equity markets are considered to be high-risk investment option. With an interest rate hike, FIIs start withdrawing from stock markets. Due to the heavy selling pressure and drained inflow of fresh investments, stock markets witness erosion of capital. Investors take refuge of safe investment haven like bank deposits. In high inflation situation, the Federal Reserve opts for increasing the interest rates.
Such economic scenario makes the Reserve Bank of India increase its own Repo rate to combat depleting capital markets. Weak investment portfolios, tapering inflow of foreign investments, less money for circulation in economy, weakens the Indian Rupee against a healthy US Dollar. Thus, in Indian economy, the revenue generated in Rupee from exports take a hit, while the importers have to shell out more Rupee to pay the import bills. This may end up ultimately hurting the country’s GDP.
Contrarily, if the Reserve Bank of India decides not to react to control the supply of money, the situation may worsen where foreign capital inflow into government securities may shrink further.
Globalisation has intertwined world economies such that the economies have become highly interdependent. The US economy even though experiencing a slowdown lately, still holds an impactful position on global financial markets. The US inflation will have ripple effect on not only India’s economy but economies around the globe.
Hope this gives you a detailed perspective of the US inflation and its impact on the Indian stock market.
Do write back to us your take on US inflation and post your relevant queries, if any, in the comments section and we shall be more than glad to respond.