Sunday, January 16, 2011

Rising food prices and energy prices drive inflation concerns in India and other regions

When 50% of personal income is spent on food and food prices increase over 16% from the prior year, a country will likely face economic, political and investment challenges – this is India’s situation today. Overall, India’s wholesale price inflation is up 8.4% from a year ago. Factors contributing to the price increase are 1) high energy prices (crude oil is India’s largest import), 2) growing world demand for food, 3) poor harvests, 4) the impact of La Nina weather patterns and 5) speculation by commodity traders. Global food prices have risen 32 % since June 2010, according to the United Nations Food and Agriculture Organization’s world food price index (which tracks the prices of meat; dairy; cereal; oils and sugar).

MY TAKE: Inflation concerns are increasing in other developing regions as well, such as Indonesia and Russia, and government leaders in China and the European Union are discussing the need to manage inflation. In India, the Reserve Bank of India (RBI) will likely continue to increase interest rates to manage inflation. However, this strategy could slow the country’s economic growth. Note for equity investors: while there are few absolute rules in the investment process, equities generally perform poorly when an economy’s inflation rate is above 6%. An inflation rate between 1-3% tends to be the economic “sweet spot”. With high inflation, India’s Sensex stock index has dropped 8.9% in the past two weeks.

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