How to control Inflation

Beside the policy inaction, sky touching inflation was one of the biggest deterrents to FIIs. Inflation remained uncontrolled and high for more than 10 months of 2011 fiscal year . How ever it is not inflation in itself that acts against the Fll inflows. Rather the action taken by central bank to curb inflation has impacted the flows. The RBI has hiked its key policy rates 13 times (totaling 350basic point) since March 2010 to tame demand and in turn, curb inflation.

Since the fill investments are primarily driven by the stock market return, which in turn depend  on the corporate performance a sharp  increase in interest rates has and will probably impact corporate profitability .This has indirectly impacted Fill investments in the stock market .If we look at the rise in the interest cost (excluding financials) for BSF 500 companies between the march 2010 quarter , which the RBI started raising the interest rate , and the September 2011 quarter , it is up by almost 60 percent. For the latest quarter (Q3FY12), out of 199 companies (excluding financials), the interest cost is up by 33.62 percent on yearly basis.

In turn of percentage of sales, the interest cost has increased from 2.2 percent 2.8 percent of sales .This factor has played its on part in bringing down the overall profit margin of the companies from 9.8 percent to 5.1 percent in the same period .We believe that the interest rates have peaked of for now and we may see some sort of easting in FY13. Indranil Sengupta Chief Economist for India at Boa will reduce rates by 200bps in two parts first by 100 bps in the first half of fiscal 2013 and then by 100bps in the second half “He further said that this will lead   to “leading rates coming down by 150bps”.This definitely going to be a booster for the sagging Indian economy .The 50bps CRR cut effected by the RBI  in its January 24 meeting is a sign of thing to come .This cut itself is expected to inject almost 32000cror in to the system .

A cut in leading rates will not only reduce the cost of companies and help them to post good numbers, It will also help In another way .Lower interest rates will help equities to attract an increasing amount of portfolio allocation between equities and bunds .The lower interest rate will make the equities look cheap (though lower discount rates while valuing equities), and will make the bounds unattractive .In 2011, we received 42068 Crore in dept compared to the outflow from equities.

Data for the last few year also indicated that whenever there is a sharp decrease in interest rates, the Fll investment increase with a little lag effect .For example 2009, we received a total of USD 17 billon of FLL investment after the reduction in key policy rates by 1.75 percent in addition to the 2.5 that we witnessed in the last quarter of 2008.”Even during 1995-1996, when the market was similar to what we saw last year, there was huge rally immediately after the first rate  cut itself “,says Jyotivardhan Jaipuria ,MD &HOR ,DSP Merrill Lynch (India ).Therefore be we believe that   a reversal of  interest rates in 2012is definitely going to reverse the trend of Fll ,and they will start investing  in Indian equities again.