Market Outlook-VRK100-14062011

Market Outlook

In a state of flux

Rama Krishna Vadlamudi, HYDERABAD June 14, 2011


With Sensex hovering around 18,250 and Nifty well below 5,500 at the end of June 13, 2011, the Indian stock market looks to be in a lackluster phase. Investors seem to be worried about inflationary concerns, GDP growth deceleration, lack of governance, policy paralysis and political controversies surrounding anti-corruption stirs. However, investors are looking to a good monsoon, some solution to the anti-corruption agitations and some policy reforms. It remains to be seen whether investors’ expectations will be met. More rate hikes are expected from Reserve Bank of India in this fiscal year.

Inflation

Food inflation proves to be a nemesis for the Government with the latest figures showing a jump in food inflation to 9.01 per cent for the week ended May 28, 2011 compared to previous week’s 8.55 per cent. There is a big mismatch between supply of and demand for food items. Adding to the supply constraints is the rise in demand for food fuelled by rising income levels for the middle income groups in the urban as well as rural areas. Government seems to be having no right solution to control the food inflation in the immediate future. The Government seems to have passed on the buck to the RBI.

RBI rate hikes

Reserve Bank of India has been increasing policy interest rates for the past one year in order to contain inflationary expectations in the economy. It is expected to increase the benchmark repo rate by another 25 basis points or 0.25 per cent when it announces the mid-quarter review of its monetary policy on June 16th. The rate hikes are expected to continue for another two to three quarters. The markets have been bracing themselves for a further rate hike of 50-75 basis points in policy rates in this fiscal year. The banks may absorb some of the rate hikes themselves by compromising on their net interest margins and may pass on only a portion of the rate hikes to borrowers. The banks’ margins at present are at elevated levels giving them some cushion to absorb the rate hikes.

India’s GDP Growth

In the last four quarters, India’s GDP growth has come down substantially. After touching a high growth of 9.40 per cent (year-on-year) in the January-March 2010 quarter, the growth rate has come down progressively to 7.80 per cent in the January-March 2011 quarter. But the consumption theme seems to be in good shape despite the visible signs of a slowdown in the economy.

FII inflows

After pumping in $ 17.5 billion in 2009 and $ 29.4 billion in Indian equity markets, foreign institutional investors (FIIs) have slowed down their investments in Indian stock market during this calendar year. At $ 85 million of net inflows in this calendar year, their investments have been almost negligible. However, in the first two weeks of this month, they have put in $ 467 million or Rs 2,103 crore in the Indian equity market. The FII appetite for Indian stocks will depend on several global factors, including inflationary concerns in India. The US Federal Reserve (Fed) has been buying bonds worth $ 600 billion. The buying programme, known as Quantitative Easing 2 or QE 2, is coming to an end on June 30th. It is not yet clear whether the Fed will continue or stop its easy money policy after June 30th. If the Fed continues with another round of bond buying or QE 3, this easy money from the US will chase commodities and may push up commodities’ prices which may be negative for India in general.

Commodities

In the last one month, most of the commodities have come off their inflated levels. Silver has lost 30 per cent from record levels of close to $ 50 (per ounce) levels to $ 35.5 now. Crude oil on Nymex has come down to $ 97 (per barrel) levels with Brent crude hovering around $ 119. But gold prices remain steady at around $ 1,530 per ounce. Gold may continue its dream run for some more time as Europe is going deeper and deeper into a bigger mess following the sovereign crisis affecting Greece, Portugal, Ireland and Spain adversely. The latest news from Europe is that Standard and Poor’s has cut Greece’s rating making it the least creditworthy nation. The ratings agency cut Greece’s rating three notches from B to CCC and said the country was likely to default on its debts at least once by 2013. With such anxieties, most of the commodities may come down going forward but gold may remain at elevated levels because of its status as a ‘safe haven’ asset in times of economic woes.

India imports 80 per cent of its crude oil demand making it vulnerable to oil prices. High oil prices increase inflationary expectations in India which in turn adversely impacts India’s growth rate. High oil bill is likely to increase fiscal deficit as the Government is unable to pass on fully the rise in international oil prices to consumers. Diesel, LPG and Kerosene are heavily subsidized in India.

With problems persisting in the Middle East, low inventories and lack of spare capacity, crude oil prices may not come down significantly in the near future unless something dramatic happens in OPEC (the body of oil exporters).

The US dollar index (against a basket of six major currencies, like, Euro, Yen and Pound Sterling) is around 74.5. The US dollar has been weakening against these major currencies in the last six months. However, in the last one week, it has shown some resilience and the index has moved up from lows of 72.5 to the present 74.5. The dollar’s overall weakness is pushing up commodities’ prices to some extent.

Global factors

The Dow Jones is at around 11,950 well below 12,000 after reaching a high of 12,800 recently. The S & P 500 is hovering around 1,270 after reaching a high of 1,360. The US indices have been in a bullish range in the last six to eight months. However, the Asian indices have been mostly in bearish territory. The Shanghai Composite (China) is at a low level of 2,700. The Hang Seng (Hong Kong) index is at 22,500 and Nikkei 225 is at a weak level of 9,400. The FTSE 100 and DAX indices are much stronger at 5,770 and 7,080 respectively.

China is going through its own problems. The non performing assets of Chinese banks are expected to go up significantly in the next one year. The central bank there has been increasing interest rates to tackle inflation. China wants its growth rates to slow down a bit to avoid any hard landing. There are concerns of overinvestment and overcapacity in China’s manufacturing sector. Following the global financial crisis of 2007/2008, China had pumped in huge amounts into its infrastructure and manufacturing sector.

Summary

The Indian Government and the RBI have to tackle inflation both from the fiscal and monetary angles. Some economists have suggested that allowing Indian rupee to appreciate against the US dollar may help in containing inflation in India. The data from RBI indicates that it has not been intervening in the foreign exchange market. The Government and RBI have to take both immediate and long-term measures to tackle inflation head on. However, the Government seems to be in some sort of a gridlock embroiling itself in controversies about how to tackle corruption monster. The general impression is that the Government may not be able to push the economic reforms forward in such a situation. The disinvestment programme seems to be in a limbo. The markets have noticed this policy drift and have been expecting further slide in stock indices. Investors need to be cautious at this point of time. As such, it is not a bad idea to hold some cash and wait for a correction and start buying Indian stocks at Sensex levels of between 16,500 and 17,500.