Investors should be well prepared to grab bargain opportunities in the coming future
Investors should be well prepared to grab bargain opportunities in the coming future
In the past two years, the world has seen unprecedented monetary and fiscal interventions to stem the economic effects of a COVID-19 recession.
Central banks and governments around the world are gearing up after increasingly easing monetary and fiscal policy.
The US has promised several rate hikes over the next few quarters, setting the trend for the rest of the country. The US dollar acts as a reserve currency, meaning that a rise in the US interest rate will depreciate most other currencies while the dollar strengthens.
The dollar boom is particularly damaging to India for two reasons: 1) the price of imports, namely oil and food imports, will become much more expensive, and 2) chasing the dollar will drive money out of our capital markets. This scenario is reminiscent of the famous speculator George Soros’s royal circle of Reagan, in which the US budget deficit widened while interest rates rose. This meant that the US economy improved while strengthening its currency.
Consumption, as well as growth, was funded by foreign goods and capital. However, this cycle was vicious for other countries.
high inflation, low growth
India will face high inflation and low growth due to several factors. Inflation from import prices will certainly hurt the economy and the accounts of both industries and ordinary consumers.
A higher interest rate regime would mean that the government’s fiscal deficit widens further due to higher lending rates on government securities. The government will have to cut fuel taxes due to increase in oil prices, further reduction in revenue. As Warren Buffett said, interest rates act as the gravity for stock prices.
The stock market should ideally correct as per the rate hike by Reserve Bank of India. In addition, existing G-Sec holders may also face a cut due to rising rates depending on their yield and coupon rate.
shrinkage principle
Additionally, high inflation will hit the FMCG industry (and others) due to lower margins and inability to raise prices. However, they deal with rising costs and stagnant prices by using a principle known as shrinkage. Reduces the amount of goods sold while keeping the price constant (you may notice that your packets of biscuits are getting lighter).
While FMCG companies may try to maintain their profit margins, it is difficult to imagine a world where they can support growth in sales and earnings.
The two major export industries that India boasts of are IT and Pharma. On the one hand, the depreciation of rupee is a positive factor for these companies as they make their money in dollars. Therefore, they benefit from exchange rate changes, at least in the short term.
signaling slowdown
However, rising rates in the US would signal a slowdown, which would lead to a reduction in consumption. The low business activity level will translate into problems especially for the IT industry. Besides, domestic business activities are also facing constraints due to rising rates and tight fiscal expenditure. These factors have a dual effect in hurting the IT industry, which weathered the COVID-19 storm relatively well. Additionally, export duties and restrictions play a significant role in hurting metal exports. The metals industry, which had done well, is now facing increasing pressure from trade restrictions imposed on it. Therefore, profiting from the depreciating exchange rate will be challenging.
The increase in exports due to depreciation acts as a stabilizing factor for the currency, without which depreciation can become more powerful. In addition, high interest rates also affect the cement industry, which thrives in a low interest rate regime. Cement companies will face lower demand due to higher rates and higher costs due to rising fuel prices.
The automobile industry is another sector that benefits from the low interest rate regime. High import costs coupled with high interest rates act as a headwind in the automobile industry.
However, these factors are excellent indicators for the investor as they indicate further lower prices.
Investors should currently sit tight and wait for further developments in the next few months, avoiding any investment bouts while passively indexing.
At such times, it is necessary to remember a quote by Baron Rothschild (a formidable 18th-century banker), “Buy when there is blood in the streets”.
(Anand Srinivasan is a consultant and Shashwat Swaminathan is a research associate at Ionian Investment Services)