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Markets look beyond current economic challenges

LiveMint logoLiveMint 12-05-2014 Krishna Merchant

Retail inflation and factory output data released on the last day of voting continued to highlight economic stress and price pressures in the system, which will make it difficult for the Reserve Bank of India (RBI) to cut interest rates. They also underline the challenges the new government will face.

Consumer price inflation rose to a three-month high of 8.6% in April from 8.3% in March on the back of higher food prices, which rose to 9.7% due to bad weather. Inflation concerns will be exacerbated if El Niño leads to poor rainfall, further stoking food inflation. There was some relief on the core inflation front, which dropped to a four-month low of 7.7% in April. However, if the economy recovers and there is gradual pickup in demand led by increases in private and government consumption, core, or non-food and non-fuel inflation will start rising again. The core inflation calculated from the Wholesale Price Index (WPI) was at an eight-month high of 3.5% in March, indicating producers still have some pricing power.

“Core inflation will remain sticky at around in 7.5-8% for most of this year because inflation in the services segment remains high as there is strong demand in urban areas and there is lack of competition,” said Gaurav Kapur, senior economist at Royal Bank of Scotland Plc.

Graphic by Naveen Kumar Saini/Mint

Also, industrial output contracted 0.5% in March, dragged down by mining and manufacturing activity. Despite anaemic growth and depressed consumer prices, the central bank had maintained a hawkish stance during its monetary policy statement in April. It wants consumer price inflation to drop to 6% by the end of next year, so it is unlikely to cut interest rates any time soon.

Given this economic backdrop, is the 36% rally in the BSE Bankex in the past three months justified? “Equity markets are looking beyond two or three quarters. If a stable government is formed and broader set of actions taken by the new regime are positive, the fundamentals will not get affected by the bad monsoon,” an analyst from a foreign brokerage said. “The political momentum is very strong and investors do not want to miss out on this rally. The bad loan problems will continue through 2014-15.”

With exit polls predicting a majority for the National Democratic Alliance, investors in shares of banks will for now ignore the underlying economic challenges that the new government and RBI will face.

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