Why inflation may become a non-issue for investors by March 2023 – Blue Barrows

For several decades, the world took inflation for granted. That’s because inflation has been under control in the last 40 years, providing great comfort to central banks worldwide.

How It All Snowballed: In A Nutshell

Several factors helped keep inflation down for four decades. Chief among them was due to global integration. Developed economies began sourcing from China at competitive rates. China emerged as the manufacturing hub for the developed world. India supplied cheap labor through BPO/KPO and IT services, while Ukraine and Russia addressed global energy needs. At the same time, in the developed world, the population began to age. With senior adults tend to consume less and save more. That placed a curb on the demand in the developed economy. But it wasn’t until Covid-19 hit the world that sudden change ensued.

Supply constraints came in. Feeling the pressure, the developed world began to apply China plus one policy. Crude oil prices, the biggest driver of inflation, started to rise significantly. All these changes occurred simultaneously and rapidly. If these had to transpire individually, we would not have witnessed the kind of impact we’ve seen in the world.

Since inflation was barely a topic of discussion in the past 40 years, global Central Banks suddenly felt the heat and had to take immediate measures to curtail the sharp rise. After several decades, the US Fed hiked interest rates by 75 bps consecutively in 2 months: a feat not seen in the US for decades. In India, the RBI hiked the interest rate three times in 2022.

Is the Worst Behind Us?

Now the moot question is if the inflation pain is over. Several economists and finance houses are divided over the issue.

Why is the world at large worried? Because inflation curbs demand and reduces capital expenditure. The world economy is also facing a slowdown. Hence, worries about inflation could further aggravate the situation. But looking at the available data points, we believe inflation in the developed market may continue for a while. This is because the developed economy will have to weather higher energy prices. At the same time, China plus one policy means that their average purchase cost can increase as no other country can have the same economies of scale that China has.

As far as India is concerned, we believe inflation will come down. Why are we optimistic? While inflation has remained more or less stubborn in the US and other parts of the world, in India (for three months in a row), CPI inflation has reduced. For instance, the inflation data in May was lower than in April. In June, it was lower than in May, and in July, it was lesser than in June. Even wholesale inflation is trending down.

So Why Do We Believe Inflation Will Trend Down for India?

Primarily, inflation rose due to a surge in crude oil and other metal prices. Simultaneously, the rupee weakened against the US dollar. Typically, when the rupee weakens against the dollar, it increases the cost of landing on Indian shores — since India is a net importer of crude and other items.

Fortunately, crude oil prices have begun easing and are currently trading below $90 per barrel. The rupee, too, seems to have stabilized after going as low as Rs 80 against the dollar. We opine that from this level forward, there would not be much downside pressure on the rupee, and it could likely start to appreciate. We also believe that crude can move down to $80 per barrel. This would ease pressure on Inflation. At the same time, metal prices such as copper, aluminium, steel, etc., have begun correcting, which has helped reduce inflationary pressure.

The Way Forward

Persistent inflation could persist in the developed market but not in India. What does this mean for inflation if it has to cool down? The RBI assumed an aggressive stance in hiking interest rates. For instance, we saw two 50bps rate hikes in the last two monetary policies and the RBI could hike rates one last time. In other words, one should not expect aggressive rate hikes from RBI in the coming months. Perhaps in 2023, we should expect rate cuts from the RBI. If that occurs, based on our views, it could boost the CAPEX and the consumption cycle in the economy.

That makes us believe that the worst of the inflation and the fear of rate hikes are in the rear-view mirror. We are not saying that inflation will diminish immediately. Instead, the trajectory is likely to stay downward. I believe that by March 2023, inflation will not be a topic of discussion among equity investors.

(The author, Sunil Damania, is Chief Investment Officer, MarketsMojo)