Rising inflation may be a drag on market: Nomura

Bond Market's Far Ahead Of Dalal Street In Factoring In RBI's Policy Moves

THE relief that market participants may have felt from the Reserve Bank of India's (RBI) decision to keep interest rates unchanged may be be short-lived. 

    According to a Nomura Financial Advisory and Securities report, inflation will continue to move up, not only on a base effect, but also on demand strength in an economy that is able to manifest itself in rising manufacturing inflation. This, the report says, should lead to a market correction and underperformance by rate cyclical in the short term. "We believe India's equity market is behind the bond market in predicting a policy tightening. This would be priced in over the next couple of months," says the brokerage in its India strategy report. 
    Key themes it expects to emerge this year are the return to growth and risktaking, a renewal of the capex cycle, strong capital flows, an appreciating rupee, an exit of loose monetary policy and marginal consolidation of the fiscal deficit. RBI left key interest rates unchanged in its policy review last week, though it hiked CRR by 75 basis points. 
    The broking firm's report adds, "Although we have been expecting a rate hike, the fact that RBI has opted to keep rates unchanged doesn't constitute a fundamental change. In our view, the tightening is inevitable. We believe inflation remains the key issue, which will drive the market, and we still expect the market to face some more downside risk from here." 
    According to data analysed by the broking house, the momentum has shown a fairly negative correlation with inflation. An explanation for that may be that conditions preceding inflation are the best for markets — corporate pricing power and monetary policy have to be in good shape before inflation picks up and vice versa. 
    Food inflation is now being joined by wider systemic inflation, driven by demand-side factors, as expansionary policies work their ways through the system, the report says.