After being battered in 2008,the global financial system is likely to begin recovering in 2009. In all probability,the Indian markets will continue to be under pressure in the first half of calendar year (CY) 2009,but could begin inching up in the second half. However,dont expect a rapid rebound as many negatives continue to dog the markets.
The global slowdown
The US economy is not out of the woods yet. The governments $700 billion relief package will provide liquidity that will enable companies to survive temporarily. For instance,the three automobile giants have received a relief package of $17 billion,which will last them till March. But the larger question is whether their fortunes will improve thereafter.
While the US is looking at a 1-1.5 per cent negative growth this year,Germany is talking of a negative 3 per cent growth. In the UK,the banking plan is under stress and the government might come out with a second bailout package.
In the US the central bank has already reduced the Fed funds rate to zero,thereby exhausting the option of further cuts. Now the government will engage in quantitative easing or printing currency: so far it has printed $650 billion. These steps are keeping the system afloat. But it will take a lot of time before the credit markets sort themselves out.
In the past few years,an inflationary bubble had been created based on debt. Now with de-leveraging,the size of economies is shrinking. Companies had created capacities based on the larger-world scenario. The adjustment process will take some time.
The US is still debating how deep the recession is going to be and what its full impact will be. In this risk-averse mode,when people are investing in US treasury bonds giving zero per cent returns,they will not invest in emerging markets like India, says Aseem Dhru,chief executive officer and managing director,HDFC Securities.
Risk aversion and FII flows
The Indian markets saw foreign institutional investors (FIIs) pull out $13.4 billion in 2008 against a cumulative inflow of $44.5 billion over the past four years. Unless FIIs return in strength,the markets cannot rise on the strength of investments by retail investors and domestic financial institutions alone.
Fund managers are hopeful that FII inflows might resume in the latter part of 2009,especially from pension funds and long-only mutual funds. Says Sivasubramanian KN,senior portfolio manager-equity,Franklin Templeton Mutual Fund: Slow growth in leading developed economies means that economies that rely on domestic demand and are growing fast offer better investment opportunities and have a better chance of attracting new capital. Amitabh Chakraborty,president,Religare Securities is optimistic. We are seeing risk appetite increasing. Against the outflow of $13.4 billion in 2008,we would expect net $5 billion inflow in 2009,that is in effect a $19 billion positive swing, he says.
Weak corporate results
With demand slowing down and credit flows to corporates getting squeezed,corporate earnings are likely to be affected in Q3 and Q4 FY09. We may see sales decline,both year-on-year and sequentially. We may also see a depression in margins due to the high commodity prices of the past,and rise in interest costs. If you keep oil companies out of the picture,other companies are going to report pressure on all fronts in Q3 and Q4, says Dhru. Adds Anup Bagchi,executive director,ICICI Securities: Earlier,we had a high-cost,high-revenue economy. It will now adjust to a low-cost low-revenue economy. That adjustment pain is what we are seeing in the markets at present. Gradually inventories will get adjusted,companies will engage in cost-cutting,and so on.
Ballooning fiscal deficit
The combined fiscal deficit for the centre and the states in FY09 is likely to be about 10 per cent of GDP. Increasing fiscal deficit could result in increased government borrowing,which would crowd out corporate borrowing. This is not a concern currently,but will become so once corporates have recovered sufficiently and need more funds.
Impact of politics
The national elections this year and the nature of the government that is formed will determine the pace of reforms over the next five years. For enhancing productivity,labour,pension and other reforms need to be pursued. This will be possible only if the new central government is both strong and positively predisposed towards reforms. A rise in geo political tensions in the Middle East or in the subcontinent is yet another risk that the markets will have to contend with.
Against the negatives mentioned above,several positives also exist:
High growth rate
When the entire world is struggling with a recession,India and China are dealing with only a slowdown. When the US was growing at 2 per cent,India was growing at nine per cent a 7 percentage points differential. Now when the US is expected to grow at minus 2 per cent,the Indian economy is expected to grow at 5 per cent (FY10). In the near-term,GDP growth is expected to moderate due to a cyclical step-down from the high growth rates of recent years. However,India will still be among the fastest growing economies in the world, says Siva.
Rising income levels and higher infrastructure spending have been the backbone of Indias shift to a higher growth trajectory. Domestic consumption and investment constituted 67.8 per cent and 31.9 per cent of GDP growth in FY08. Gross exports stood at 13 per cent of GDP in FY08,while net exports to GDP ratio were negative. Thus,essentially,India remains an economy driven by domestic demand that is less likely to be affected by the global trade cycle.
Americas current account deficit and weak economy dictate that the dollar is likely to weaken. Last year the world was seeking safety,so people converted from other currencies to the dollar. Moreover,the US had about $5 trillion of investment abroad. A large part of these funds went back to the US as hedge funds de-leveraged and mutual funds tried to meet redemption pressures. That caused the dollar to appreciate last year.
But those events have already played. Earlier,almost 70 per cent of all foreign currency reserves of nations were kept in the US dollar; now that number is down to 65 per cent. The euro and the yen are emerging as alternate currencies. So the demand for the dollar is expected to ebb.
As the dollar weakens,non-dollar denominated assets will become attractive. With interest rates in the US at zero,US investors will seek investment opportunities outside. This could lead to the beginning of the dollar carry trade.
Falling interest rates
Inflationary pressures are now a thing of the past with WPI inflation expected to fall as low as 1 per cent by May. Crude prices are expected to remain in $30-50 per barrel range this year. The sharp fall in global crude oil prices and commodities is a positive from the point of view of current account and fiscal balance. Low commodity prices are also giving more room for manoeuvre to the central bank. After Fridays rate cuts (repo: 5.5 per cent; reverse repo: 4 per cent; and CRR: 5 per cent),we have moved to a low interest-rate regime. Pressure on corporate margins is expected to ease going forward as borrowing costs come down and the sharp decline in commodity and energy prices reduces input costs, says Siva.
Low interest rates could well spark off a revival of the markets and the economy. A low interest-rate scenario is a precondition for a rising stock market, says Dhru.
Today,despite having liquidity,banks are wary about lending to corporates for fear of loans going bad. Says Bagchi: My estimate is that by Q1FY10 credit will begin to flow. And as loans become available to end customers at lower interest rates,the cycle will begin to turn.
Unlike January 2008,the Indian market is attractively valued today. Today our market capitalisation to GDP ratio is about 0.66 whereas it had crossed one in January 2008. The Indian stock markets are trading at about eight times FY10 earnings. So the market has value. Says Siva: India has now gone from being one of the most expensive stock markets in Asia to being one of the cheapest.
Thus,the markets have already priced in the negative scenario. As the world realises that India is better positioned than a lot of other economies,interest is bound to return to the Indian markets. It is expected that the Indian markets could be among the first to bounce back once the global situation stabilises. For investors this is a good time to begin accumulating stocks through systematic purchases.
India: IN FINE FETTLE
Country GDP growth rate(%)
Euro Area -0.2
IMF forecasts for 2009 GDP growth