Auto industry majors feel RBI rate hike will dampen demand

“The sector (automobile) is already reeling under pressure due to high input costs and rising fuel prices and the steady hike in interest rates will affect sales,” General Motors India vice-president (corporate affairs) A Balendran said

Mumbai: With the Reserve Bank of India (RBI) raising key interest rates by 25 basis points, automobile industry captains feel the move will further dampen demand in the auto sector of the country, reports PTI.

“No doubt, it (RBI’s move) will have a negative impact on the automobile industry. It was expected... Now we would like to see how much banks pass the burden (on to customers),” Mahindra & Mahindra (M&M) president, Auto & Farm Equipment Sector, Pawan Goenka told PTI here.

Mr Goenka is also the president of the Society of Indian Automobile Manufacturers (SIAM).

The central bank raised key interest rates by 25 basis points today, the tenth time since March 2010. The RBI has raised the short-term lending (repo) rate by 25 basis points to 7.50% and the short-term borrowing (reverse repo) rate by a similar margin to 6.5%.

“The market has already slowed down... This latest hike will further dampen the auto sector... It is a matter of concern,” General Motors India vice-president (corporate affairs) A Balendran said.

“The sector (automobile) is already reeling under pressure due to high input costs and rising fuel prices and the steady hike in interest rates will affect sales,” he said.

Auto major Fiat India also sees a significant impact on the sector.

“Going forward, the RBI’s initiative will hurt the auto industry by hitting sales. The industry is (already) under pressure and this fresh step will further aggravate the situation,” Fiat India president and chief executive officer Rajeev Kapoor said.

Rajkot-based three wheeler-maker Atul Auto also feels the rate hike will further affect demand. “Definitely, it will have an impact on the automobile industry. However, I am confident the industry will face this challenge boldly,” director Vijay Kedia said.

“Things like high inflation, rate hikes and the fuel price increases point out to a tightening in the situation,” he said.

According to SIAM, total sales of vehicles across categories registered a growth of 13.40% to 13,70,786 units in May, as against 12,08,820 units in the same month last year.

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Market drivers: Financial physics

How inflation, economic growth and stock prices are interlinked

Markets are influenced by human behaviour acting in herds; so it is tough to formulate laws that can explain market action, much less predict it accurately. But Ed Easterling has an interesting theory which he calls ‘financial physics’. Financial physics explains the interaction among the principles of economics and finance as the drivers for secular stock markets. In the financial physics model, two elements of economics—economic growth and inflation—drive the two financial components of the stock market, viz, corporate earnings and stock prices.

In the first set of correlation, economic growth is the fundamental driver of earnings growth which, in turn, is the primary driver of the stock market over the long term. Higher growth and higher inflation should increase corporate earnings. If inflation only bumped up earnings, the stock market would respond accordingly and move higher; but it does not.

This is where the second factor comes into play. While inflation increases earnings, it also affects the price levels of financial assets and the price level of a financial asset influences subsequent returns. Rising inflation increases the level of returns required by investors, thereby causing prices to decline. Stock prices fall as the present value of future earnings declines. To get a higher rate of return from stocks, investors tend to pay a lower price for future earnings (i.e., lower P/Es). In effect, inflation drives down P/E and, thus, offsets the inflation-driven growth in EPS.



Historically, the years with higher inflation and deflation tend to have a low P/E. When inflation is high, investors should expect that P/E would be low. If we are in a situation of higher-than-average-P/E, prices will fall—often, despite growing GDP and earnings. Similarly, in a scenario of deflation, the future growth rate for earnings and dividends turns negative and the value of stocks falls. Thus, both higher inflation and deflation cause P/E to decline. Higher inflation also reduces the purchasing power value of an investment portfolio. Thus, high inflation brings in low returns and lessens the value of what’s left. Easterling’s market valuation theory firmly makes the market level relative to the inflation rate—not a level that is arbitrarily anchored to a long-term average. This is precisely what is happening in the market today.

There are fears of rising inflation which are reflected in P/E compression—despite rising EPS (earnings per share) and GDP growth. 

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