Strategy Note /

India inflation shows its loose policy can't last (in 6 charts)

  • April yoy inflation was 7.8% versus 7.4% expectation and prior month 7.0%, and 2023 expectations are increasing sharply

  • Easy monetary policy (negative real interest rates) have supported equities but this can't last; more rate hikes to come

  • Indian equities have de-rated in the global sell-off but large EM peers are cheaper relative to history, eg China

India inflation shows its loose policy can't last (in 6 charts)
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
13 May 2022
Published byTellimer Research

India's inflation is accelerating even faster than expected and inflation expectations are increasing sharply. Loose monetary policy cannot last and the adjustment is likely to be uncomfortable for equities.

India equities (BSE 500 index) are down 11% ytd in total US$ terms, almost 10pp better than China, but 20pp worse than Brazil. Indian equities have recently de-rated but so have EM peers in the global sell-off and India remains more expensively valued versus history than these peers.

Loose policy meets inflation spike

India's April yoy inflation came at 7.8% (data released on 13 May) versus the 7.4% consensus expectation (Bloomberg) and the prior month's 7.0%. The central bank's target range for inflation is 2% to 6%.

As is the case globally, food and fuel commodity prices are biting.

The implied real interest rate is negative 3.4%. An extended period of negative real interest rates supports growth and pushes investors, in particular, into equities as long as inflation expectations remain contained and central bank credibility remains intact.

(1) Loose monetary policy support for equities cannot last

However, consensus 2023 inflation expectations are increasing sharply, now 6% compared with 5% at the start of March 2022.

Loose monetary policy will likely have to be reined in and this may make for a difficult adjustment period for equities, irrespective of the global backdrop.

(2) Because inflation expectations are sharply increasing

And there is little room for fiscal policy to counter this given the deficit as a percentage of GDP for this year is heading towards 10%, according to IMF forecasts.

(3) And there is no room for fiscal stimulus

Fading policy stimulus adds to other concerns on Indian equities.

  • Structural reform is seemingly off the table until at least the 2024 election, and civic unrest risk, resulting from illiberal politics, has not abated.

  • Indian equities are more expensively valued versus history than those of other large EMs, eg China.

  • Foreign flows have turned significantly negative (and local investor bases tend to be very sensitive to policy rate hikes).

(4) While equities PE now 10% below 5-year median

(5) India valuation higher relative to history vs EM peers

(6) And foreign flows have turned negative

Our EM Country Index in this context

In our EM Country Index we incorporate short and long-term macroeconomic growth factors but also measures of policy credibility, eg real interest rates to reflect whether policy-makers are ahead or behind the inflation curve.

Our index weights c30 factors on growth (short and long term), policy credibility, politics, sanctions, ESG, equity valuation and liquidity. The weights in the index can be changed in order to model different global themes and portfolio styles.

Among large EM peers, in our index, India ranks behind China, Taiwan and Saudi Arabia, similarly to South Korea, and ahead of Brazil and South Africa.

Related reading

India: Reform and Illiberalism after Modi's BJP state elections success, Mar 2022

Why India abstained on the Russia vote at the UN, Mar 2022

India's stimulus may not be sustainable, Feb 2022