What kind of an impact would Fed tapering have on equities?
I do not think the equity markets have really priced in the Fed tapering fully. The Fed’s balance sheet since last year has expanded by $3-4 trillion and that is a lot of expansion.
As the Fed starts tapering, some of the liquidity is going to get pulled out of the markets and it will definitely have some impact. The reason for the Fed tapering at least in the US is there is very strong employment, everybody is getting lots of jobs and a lot of people have quit the workforce and they have just made a lot of money either in the stock markets or they feel that they just do not need to work because of the stimulus packages. As a result, there is wage inflation.
If you look at the inflation forecast, while about a year or two ago, inflation was running at about 1%, the forecasts are CPI in the US is already running at 4-5%, that is pretty high and of course the forecasts are with the Fed tapering that inflation will come down next year.
We see similar patterns of inflation rising across the globe because of stimulus packages and supply chain disruptions and the demand picking up. India is slightly different in the sense that we have not had so much wage inflation, our employment activity is not as strong as what we are seeing in the US and growth is still not at its peak. The companies also are not operating at peak capacity.
So we may not be as concerned about inflation but if global liquidity starts getting reduced, that will have an impact across the globe and then we would be very reliant on our domestic flows to keep the markets buoyant.
Inflation has really been felt in India by India Inc. Until now they have been able to pass on the raw material cost inflation to consumers but at some point they will have to choose between margins or volumes. What does one need to do with inflation sensitive sectors?
There is a view that this inflationary is transitory. I am not sure I fully subscribe to that. I think it will take some time for the supply chain issues to resolve. A lot of companies and sectors are reliant on China for raw materials and that has also been a problem. The dependence on China is clearly hurting the global economy and so companies around the world have been diversifying their supply chains and trying to find alternatives and that might take some time, but hopefully that will eventually create less pressure on the companies in terms of their supply issues. So inflation is a concern but I do not think we are seeing that kind of wage inflation in India yet.
The demand side has not really picked up as strongly and so inflation is really supply led and whether companies can pass on that depends a little bit on how the demand grows because we still have not fully recovered. There is still a lot of unemployment and as that improves and demand keeps up, the companies will be able to pass on all the prices because some consumers are already feeling the pressure and we need to see employment picking up and demand keeping pace and then perhaps there may be less margin pressure on the companies. But yes, for the short term, there is margin pressure because of raw material prices.
