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Monday, January 10, 2011

How Inflation affects Sensex?

The inflation rate has started having an impact on the Sensex. The Sensex has started rocking because of the high inflation. With its widespread reach, inflation affects all aspects of the economy, and thereby the Sensex.

Last week, the markets fell after a sharp rise in food prices heightened concerns that the central bank may tighten the monetary policy more than expected. The financial stocks were among the big losers as higher interest rates could douse the demand for loans and squeeze the margins of banks.

The food price index rose 18.32 per cent in the 12 months to December 25, the highest in more than a year. The fuel price index climbed 11.63 per cent. In the prior week, annual food and fuel inflation stood at 14.44 per cent and 11.63 per cent respectively. The primary articles price index was up 20.20 per cent in the latest week, compared with an annual rise of 17.24 per cent a week earlier. The Wholesale Price Index, the most widely watched gauge of prices in India, rose 7.48 per cent in November from a year earlier, compared with 8.58 per cent in October.

Though overall, inflation moderated to 7.75 per cent in November from 8.58 per cent in October, food inflation has increased rapidly in the first half of December. High onion prices coupled with that of milk were blamed for high food inflation. This may lead to at least a 50 basis point rate hike in January by the Reserve Bank of India (RBI). One has to be prepared now for a much larger rate hike series than what one was expecting say a month ago. The RBI is scheduled to review the policy on January 25.

Quarterly corporate results due from next week are expected to show robust growth, and investors would be watching for management comments on outlook for direction. Inflation is one of the issues hurting the markets. Earnings should provide more cues on direction. Foreign funds have bought around USD 270 million of equity in the first two trading sessions this year, after pumping in a record USD 29.3 billion in 2010. According to the prime minister's economic advisory council chairman C Rangarajan, the inflation rate could be considered comfortable only when it comes down to four per cent.

He said the rate hike by the RBI will depend on the price behaviour during December and January. If the inflation rate comes down significantly, there may not be any need for action. On the other hand, if inflation remains sticky, then action will be required by the RBI. The RBI last year raised policy rates six times to rein in inflation. However, in its mid-quarterly review in December, the RBI refrained from raising rates since the system was facing a cash crunch.

It, in fact, announced measures to inject Rs 48,000 crores into the system. The RBI, however, cautioned that its measures should not be interpreted as a reversal of the tight monetary stance since inflation still continues to be a major concern.

The rising oil price presents a new inflationary phenomenon and further complicates the task of policymakers. While raising rates can do little to cap cost-driven inflation, it can help cool overall demand and contain inflationary expectations fuelled by a broad rally in the commodity markets.

Rising inflation leads to increase in interest costs, which affects the companies depending on debt finance as the cost of funds increases. This negatively affects the bottom lines of the companies.

Moreover, increase in prices leads to decrease in demand, which again affects the corporate bottom lines.
The purchasing power of people gets reduced. All these cumulatively have an adverse affect on the corporates, and thereby on the Sensex.  
Curtesy :  Ashish Gupta,ET

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