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Few bright spots in India: Why inflation threatens earnings

Sr Emerging Markets Analyst

Must-know: India’s purchasing managers' index plunges (Part 2 of 2)

(Continued from Part 1)

Bright spots

The key bright spot was that employment remained in expansion territory, though modestly. The consumer goods sector was the strongest overall—and as long as employment remains healthy, this should remain the case.

Plus, there was no mention this time about power cuts limiting production—though that may not imply that power cuts weren’t an issue. It could also be that demand dropped so much that power cuts weren’t the limiting factor.

Inflation continues to threaten margins

Once again, cost pressures due to the depreciation of the rupee increased the raw materials prices and threatened margins. Most commodities are priced in U.S. dollars, so when the Indian rupee drops relative to the U.S. dollar, costs go up faster than prices can increase.

Increased competitive pressures prevent producers from fully passing on the increased costs to consumers, so margins reduce. Given that the rupee is expected to remain weak as the US dollar is likely to strengthen, margins will likely continue to contract.

The weaker margins naturally result in lower earnings for companies, which results in lower stock prices. While the local market has been trading sideways, the lower earnings may put negative pressure on it. In the case of foreign investors, this is compounded by foreign exchange losses, so at least in the short term, India remains quite unattractive to invest in.

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