Equities can help beat inflation

The news-focus on inflation has been energised by the recent Bharat bandh. It's undeniable that inflation has been high for the past year. What can the government do in order to control it?

First, a better system of accounting for inflation is required.

The current mode of reporting WPI and that too on a point-by-point basis is flawed and susceptible to base effects. Second, the way the baskets are weighted in both WPI as well as CPI may not reflect the actual inflation impact. Policy geared to those deceptive numbers will not be optimal.

The ultra-sensitive items are food and fuel. There isn't much the government of India can do about fuel. It has to free diesel and petrol prices because 80 per cent of crude oil is imported. Ideally, it should have freed kerosene as well.

It is still subsidising gas, where it has at least the promise of higher domestic supplies in the near future.

What can it do about food inflation? A lot could be done on the supply side. Actions such as freeing up markets, creating logistics chains, which allow FCI to respond to price changes, among others, would help.

As it stands, the GoI pays high support prices for several food items and then lets, whatever it procures, rot in godowns regardless of what is happening in the mandi.

At least part of food inflation is caused by NREGA. It has raised the price of farm labour and put money into rural pockets. People can afford to buy more food. So, the demand is up and so are prices.

This can be addressed only by increasing supply. That can happen if more land is brought under irrigation, better quality seed is planted and more machinery used, among others. All very long-term.

What the GoI will probably do in the short-term is raise interest rates. This is unlikely to have a major positive impact on key items and it will have a negative impact on other segments of the economy. The GoI can also pray for a better monsoon - that would help with supply, though the messy logistics of official procurement will reduce any beneficial impact.

The impact on the stock market of all this is unlikely to be positive. The markets eventually discount inflationary expectations and oddly equity can end up being a beneficiary because it is a better defensive asset than debt in an inflationary situation.

But the immediate reaction to rate hikes and fear of rate hikes is a downgrading of equity assets.

At the same time, EPS is growing fast. If we use a rough thumb-rule, EPS will have to grow at inflation plus GDP - that means above 20 per cent - to maintain momentum. One hopes that Q1 results can achieve that.