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Stocks, Bonds, Rupee and Inflation-VRK100-10Oct2011

Stocks, Bonds, Rupee and Inflation-VRK100-10Oct2011

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What is the connection between bonds, stocks, rupee and inflation? Rama Krishna Vadlamudi, Hyderabad, analyses the interconnection of all these variables one affecting the other.
What is the connection between bonds, stocks, rupee and inflation? Rama Krishna Vadlamudi, Hyderabad, analyses the interconnection of all these variables one affecting the other.

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Published by: RamaKrishna Vadlamudi on Oct 09, 2011
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How are they interconnected
 
Rama Krishna Vadlamudi, HYDERABAD 10 October 2011
Stocks, Bonds and Rupee are declining, but Inflation remains ruthlessly high, why? This is a case of everything affecting everything. Recent decline in stock prices is partly attributed to Indian rupee’s unexpected decline against the US dollar. Rising fiscal deficit is also causing concern in the stock markets not to speak of persistent inflation driven first by higher food prices and later by manufactured products.Let us delve deeper and tackle inflation first.
Inflation – A Way of Life 
What causes inflation? Textbooks tell us that price rise is caused byexcess demand chasing limited supply. So, what is causing thishigher demand and lesser supply?If we look back at history, we find that prices are always up. In India,we are used to higher and higher prices in the last five to six years.This period coincides with enormous wealth creation (thoughrestricted to only a small chunk of population), rising procurementprices of food grains, increasing wages in the economy, boosting
 
Rama Krishna Vadlamudi, HYDERABAD 10 October 2011
www.ramakrishnavadlamudi.blogspot.com 
rural incomes, galloping real estate prices, soaring commodity prices,climbing stock prices, maverick monsoons and others.The wealth effect and the wage/income effect seem to haveprompted people to spend an increased portion of their incomes onall sorts of goods and services resulting in stubborn inflation.Rotting food grains in the government warehouses have not helpedmatters either. Agriculture yields are stagnant for a few decades.However, preening ourselves in this shining glory, we have failed toanticipate such a trend of persistent inflation. This neglect hascreated supply chain bottlenecks and posing problems in reining ininflation. Milton Friedman famously said, “Inflation is always amonetary phenomenon.” The central bank has dutifully raised interestrates by 12 times sticking to its primary dharma of price stability, butto no avail. The governments caught up in their own scandals haveforgotten to act on expenditure control or clearing up bottlenecks.
Rising fiscal deficit:
 
The biggest culprit seems to be fiscal deficit, which is on theascendant. In the last four years between 2008-09 and 2011-12, thecentral government’s market borrowings – which are raised from thebanks, insurance companies and others – have been rising at analarming rate. The yearly average net market borrowings of thecentral government for the last four years are at Rs 3,42,000 crore,which is 3.8 times the yearly average of Rs 91,000 crore between2004-05 and 2007-08. This does not include borrowing by stategovernments.Inflation is traditionally measured in three ways – wholesale priceindex (WPI), consumer price index (CPI) and GDP deflator. In India,we follow the WPI measure while the advanced economies mostlyfollow CPI measure. Services are not included in India’s WPI.
Stock markets are highly volatile 
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Rama Krishna Vadlamudi, HYDERABAD 10 October 2011
www.ramakrishnavadlamudi.blogspot.com 
Stocks are reacting very violently to all kinds of events or news items – be it scandals, mining bill imposing new tax on mining companies,land acquisition bill, government’s perceived policy paralysis, GDPgrowth slowdown, IIP numbers, growing NPA menace in banks,shrinking order books, soaring prices, etc.Market will be looking to cues from the oncoming corporate results.The quarterly results are expected to be weaker. Also, the marketswill be looking at inflation and IIP numbers that will be announcednext week.The HSBC India Purchasing Manager’s Index (PMI), based on asurvey of 500 companies, fell to 50.4 in September 2011 from 52.6 inAugust and 53.6 in July. The September figure is the lowest sinceMarch 2009.The range-bound movement of Indian stock indices will continue forsome more time till the Indian government takes some serious policymeasures or more clarity comes on project clearances or further cutshappen in global commodity prices especially crude oil or somecredible solution seems to be emerging in the eurozone’s sovereigndebt crisis.
Indian Rupee on the Decline 
Indian rupee has turned a high-beta currency of late. Pressure onrupee is coming from outflow from Foreign Institutional Investors(FIIs) who are selling in Indian stock market; sudden appreciation ofUS dollar against major currencies, like, euro and pound sterling;higher demand for dollar by Indian companies; and bunched uppayments of short-term external debt by the end of this fiscal year.
Rupee movement between 2003 and 2011:
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