Inflation, slow economic recovery, lack of investment, and inadequate jobs stare at you in the year ahead. All of that not only affects the broader economy but also influences your finances. There is more to it.
The Reserve Bank of India annual report for 2020-21 warns of a stock market bubble as more money in the financial system leads to asset price inflation. For share prices to remain high, the profit growth in significant companies needs to sustain.
The RBI annual report, presented a quarter early this year, cautions the government on inflationary pressures and poor private investment. It argues that India needs economic growth led by substantial investment from the private and public sectors. Presently, only the government is spending money through multiple infrastructure projects. For India’s economy to get to a sustainable economic growth path, private companies must start investing in expanding capacity and creating more jobs.
The report is a wealth of information. It may be a good idea for you to spare some time to give it a read once. If you belong to the financial sector, you may be able to grasp several things quickly. However, if you are new to the world of finance, you must make it a point to read the document.
Begin with the outlook
The RBI’s assessment of the outlook for the economy and inflation is the most important thing from your standpoint. “The near-term outlook is clouded, with an accentuation of downside risks and potential externalities of global spillovers,” said the report. It recommends designing public policies that put us back on a secure path of sustainable and robust growth with macroeconomic and financial stability. These two sentences are significant for interest rates and financial markets. The RBI is saying that India’s economy is vulnerable to shocks in the future. These could be both internal and external.
India needs a faster pace of economic growth to create opportunities for businesses. The government is spending money on building roads, metro networks, airports and other infrastructure. At the same time, there is intense pressure on the government finances to enhance healthcare spending. While it is a state subject under the Indian constitution, the central government must provide the money for any spending by states on health. If harsh health conditions increase their borrowing from the market, it could lead to a sharp increase in overall government borrowing. India’s healthcare spending is less than 1 per cent of the gross domestic product or GDP and the worst among G20 countries. Any significant rise in spending will call for an increase in government expenditure.
While the government mulls expanding the healthcare in the country through increased spending, it also needs to ensure that there is enough money in the system for businesses to borrow and expand capacity. Many experts are recommending the printing of money to pay people for the economic fallout of the pandemic. If that is done, it could enhance the inflation threat to the economy. Increased government expenditure, declining tax revenue limits the amount of money the government can print.
Runaway inflation is the last thing that India’s economy needs. It will throw everything out of gear. When RBI says India needs sustainable growth with macroeconomic stability, it usually means growth without letting inflation raise the head.
The RBI annual report warns against a potential threat to inflation that could erode the value of money. In one of the boxes, the RBI also warns of a stock market bubble brewing. A study of share prices presented in the annual report said that share prices are gaining in India on increased money supply from within and foreign portfolio investors. There is a limited relationship with fundamentals like the financial performance of a company.
For the current rally in the stock market to sustain, companies have to turn in more robust profit growth over the next two years. Interest rates and corporate profits are two crucial factors that determine your financial future. If we have to go by the RBI annual report, there are risks ahead to both. That does not mean you need to stop investing and leave your money in the bank. Diversifying your investments across asset classes is the key.
(The author is editor-in-chief at www.moneyminute.in)