| The slowing down of the U.S. economy has ominous consequences for India |
Neither reforms nor even the generally positive economic factors automatically suggest a vibrant stock market during 2008. Ultimately it will be perceptions, relative perceptions of the large investors — both Indian and foreign — that will matter.
The Sensex opened slightly above 20000 on December 10 but ended the fortnight sharply lower at 19162. Above 20000, the index seems to meet with resistance meaning thereby it retreats instead of consolidating and moving up to scale new highs.
For four days in a row between December 11 and 14, the index closed above 20000 _ at a new high of 20375 on December 12. But the fortnight also saw the second biggest fall for a day, of more than 750 points on December 17. On December 14, it closed at 20030 and on December 17 at 19261.
Volatility, a normal featureComparison of closings, of course, conveys only half the picture. Evidently, there was plenty of volatility not only over days but within trading sessions. Volatility, in fact, has become a regular feature of stock price movements. There was perhaps nothing unusual about last fortnight’s erratic movements.
Over the year, the Sensex has gained by 40 per cent. The big question now is whether this can be sustained. Naturally domestic and external factors matter while forecasting stock market performance. India’s growth story remains good. The GDP is expected to grow at an average 9 per cent in the next five years. It is on that basis that the Eleventh Plan was recently finalised. At the recent meeting of the National Development Council, called to finalise the Plan, Prime Minister Manmohan Singh was confident that such a high growth rate could be sustained. One distinctly favourable factor is the high saving and investment rates, which have climbed sharply to 34 per cent and 35 per cent of the GDP respectively. Moreover, given the young population profile, high investment rates can be sustained.
During the last three years of the Tenth Plan, the growth rate had averaged at 9 per cent. This year (2007-08) too growth should be of the same order despite some threats.
Threats and opportunitiesInflation has been contained if one goes by official statistics but with domestic fuel prices artificially pegged the threat of higher inflation looms large over the near term. According to latest reports, the Government will bow to the inevitable and raise retail prices of transportation fuels though not by a large margin.
Global oil prices which had soared to within striking range of $ 100 a barrel a few weeks back show no signs of receding to their earlier levels. The latest OPEC (Organization of the Petroleum Exporting Countries) meeting, by deciding not to step up output, has virtually endorsed the high price regime.
India’s oil basket has been growing and higher prices are naturally widening the current account deficit. When the Government does raise petrol and diesel prices, most domestic consumers will have less money to spend.
Other threats to the domestic economy emanate from the hardening rupee and its impact on merchandise exports as well as certain types of services exports. In rupee terms, merchandise exports have been growing at a much slower pace. Information technology companies have reported lower operating margins as the stronger rupee translates into lower receivables. This is one reason why IT stocks, once the most fancied counters, are slightly out of fashion.
For the macro economy, other negatives include large subsidies for petroleum, food and fertilizer. Since most of these reliefs are not charged to the budget but are kept as off-balance- sheet items, there is considerable opacity in public finance.
In any case, some future government will have to pick up the tab. Infrastructure has been another weak area whose problems are well documented. For the Indian economy in general and the stock markets in particular, the outside world too matters.
Disturbing global eventsAs the Prime Minister has said the external sector contributes 40 per cent of the GDP. External sector management, once the brightest spot of macro economic management, is now under stress. Not just the high oil and other commodity prices, but a number of other factors suggest that the economy cannot be kept insulated from problems outside.
In particular, the slowing down of the U.S. economy, probably sliding to a recession, has ominous consequences for India and other emerging markets. Specific financial crises such as the sub-prime housing market debacle are no longer a problem of the developed world alone. That is why the actions of the U.S. Federal Reserve and central banks of other advanced nations have a direct bearing on India and other emerging markets.
Changing investor profileForeign institutional investment in 2007 is expected to be of the order of $15-16 billion. Obviously, the actions of these global players will have a direct bearing on Indian stock prices in 2008. The other significant players in India — insurance companies, domestic institutions including mutual funds, and high net worth individuals — may not be so susceptible to outside influences but will definitely follow global cues.
One significant development has been the emergence of insurance companies with an estimated investment of $6-7 billion as the second largest category, ahead of even mutual funds. It is clear that with further financial sector reform, the role of insurance companies will only expand.
Tapping the insurance industry’s potential is just one of the many things that the financial sector reform can do.
The corporate bond market is being strengthened. There has been a flurry of activity in capital market regulation with short-selling by institutions being restored. Attempts are on to introduce a stock borrowing and lending scheme.
C. R. L. NARASIMHAN
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