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Ashwini Agarwal, of Demeter Advisors feels that two thinks that have spooked the markets are the inflation numbers and the BHEL results. He said the results may suggest that the earnings may be really lower than what the markets are already estimating.

Pankaj Vaish, MD & Head of Equities & Fixed Income, Lehman Brothers feels that the inflation story is a little bit worrying. He feels that a RBI hike alone, may not achieve much.

Excerpts from CNBC-TV18's exclusive interview with Ashwini Agarwal and Pankaj Vaish:

Q: What do you think, is there more pain to come?

Agarwal: I think what has happened is that over the last one-week ten days with two sets of bad inflation data everybody started to realise that firstly we have inflation, which is going to be very hard to correct in the short run, and the policy options that the government has are very few. Given that you want to keep the fiscal deficit under control, you want to ensure that the domestic economy keeps growing and the fact that we run a current account deficit that doesn’t really leave you that much room to maneuver. In this scenario I think that’s a part that is spooking everyone.

The second thing that happened is that BHEL results yesterday have suddenly gotten everybody to realise that earnings actually might turn in much lower than what everybody was thinking. So these two factors will weigh down the market locally at least even though as you mentioned in your opening remarks globally I think the base case environment is starting to improve a little bit.

Going ahead, I think next week will continue to be a little bit tough and then I am hoping that Infosys guidance due on the 15th might lift the sentiment a little bit. But we have to see, one doesn’t know.

Q: What do you think the previous lows will hold or is all this inflation interest rate talk would lead us to violate those lows?

Vaish: A lot of the clients we talked to have just turned extremely cautious and everybody wants to wait and buy at lower levels. So going by round numbers the next one we hear people talking about is 14,000 is where they want to buy. We ourselves are actually still bullish. We think that a lot of the bad news is built-in. We have thrown earnings slowdown, inflation, foreign exchange derivatives, all sorts of stuff you can think of at the market. In some sense we are not that far away from the January 22 low at least on the broader larger cap indices.

So our own view is the inflation story, yes, is a little bit worrying and the last time when we talked that was the one sort of caveat we had about the bond market also. But I think just to me it seems a bit surprising that we focus so much on the Wholesale Price Index (WPI), it’s only a step away from looking at commodity prices. So in fact the number today is pretty much all came from this iron ore number also. I think it would be better if we started getting Consumer Price Index (CPI) data published a lot more frequently and people looked at what kind of pass-through there is.

So inflation has now become something that everybody watches and gets very concerned about. But our research team actually looked at going back last five years and actually found positive correlation between sales and inflation because everybody thinks of autos will have a problem with rising input cost. But when you look at steel manufacturers are 8% of the market whereas auto and auto parts are 3%.

So, at least empirically they have found positive correlation. So maybe we need to take the inflation thing a little sort of less in a panicky way than the market is watching it like a bond trader right now.

Q: The fear is that we will take some policy action which will cripple the equity markets for the next few quarters, another rate hike or CRR tightening et cetera, which might lead us the China way. Is that a legitimate fear?

Agarwal: I have sort of personally been of the view that RBI will not take this bet. I mean 10 days ago if you’d asked me this question I would have said that look RBI is not going to tighten any further than they have already tightened. The interest rate differentials between India and the US are already way too high and to tighten in an environment like this would mean that the rupee appreciates and the domestic economy slows down significantly, which is not something that the government would like.

But just reading into the comments that the government has been making earlier this week, it seems to me that we should expect some tightening maybe not in interest rate increase but definitely a CRR increase.

Coupled with that, the tightening you are seeing rising costs of financing for the domestic corporates coming in from whether you call it hedging costs on foreign borrowings, whether you call it hedging cost on suppliers credit whichever way you want to put it. The bottomline is that cost of finances for domestic industry will increase. I am not sure how much it will cut down on demand because demand has already been squeezed down quite a bit.

For the last one and half years, banks have been gradually cutting consumer credit for a host of reasons. So I don’t think on the demand perspective there is going to be that much of an impact. But I think on corporate balance sheets there will be some impact.

Q: Is that a risk you perceive that whatever the inflation perception is interest rates might actually harden contrary to expectations at the start of the year and that might derate the equity market further?

Vaish: I think the equity market has already been reacting to that. In the bond market the ten-year has backed up to almost 8%. So, I think you have already seen the impact of that. I agree with Ashwini that at this stage an interest rate hike by the Reserve Bank, I don’t think really achieves anything in terms of if they are worried about this supply-constrained inflation and in terms of the rupee that Ashwini was mentioning.

So I just don’t see what that would achieve at this stage. But the secondary market has already been taking interest rates higher and the equity market like I said is reacting just as strongly to it as bond traders are.

Source: Moneycontrol.com