The Indian Economy-What Next?

Jan 2008: Sensex kisses 21000. There's a general feel good factor in the Indian economy. The domestic currency is strong against a declining dollar (due to subprime and a weak industrial average numbers) due to strong FII inflows. Mutual Funds are flourishing, investor wealth has surged by trillions of rupees, every second person wants to enter the market and there is talk of the Sensex touching 40000 by 'experienced' analysts. (This despite the fact that the index @ 21000 is trading at very unrealistic 20-22.5 times FY09 multiples). To counteract sharp appreciation in the rupee, due to strong capital inflows and protect the exports sector (mainly IT and textiles) from huge losses and a weak bottom-line, RBI Governor YSR Reddy, steps in. The RBI buys huge amounts of dollars to keep the currency in and around 39-40 to the dollar. This is followed by it giving a target of 5% inflation and making it a priority as part of its monetary policy. Inflation falls to 3% owing to corrective action including CRR and repo rate hikes. While most markets and countries go into a slump with subprime losses looming large, India seems apparently unscathed. Excluding two main banks (SBI and ICICI), Indian banks are not greatly exposed thanks to fewer international borrowings. India is expected to be on target for a 9-10% GDP growth rate for FY07-08.
Jun 2008: Sensex has fallen by more than 35% to 13500 and the stock market is in a strong bear grip. A bear market is one where stock prices fall after a downturn of 15-20% or more on multiple indices accompanied by widespread pessimism. India and China are ranked to be the worst performing markets uptil now with the Sensex having its longest losing streak since 2001. FII outflows have eroded Rs 29.46 trillion rupees of investor wealth and there is a bearish sentiment. All support levels are broken, technicals are not working. This is a hugely sentimental market...much the like the Indian people. Finally it is the people who make the market, isnt it? The fundamentals which seemed so strong back in January are not talked about. Inflation stands at 11.42% for the week ended 14th June. Commodity prices are surging and the common man looks on helpless.
What just happened here? India was the next growth story and the only glimmer of hope for global investors. Emerging India it was said. So how the downturn? Let me ask you a question: What is the single most important factor that accounts for more than 70% of India's imports, has a direct impact on IIP numbers (Index of Industrial production), has a high weightage in WPI inflation and can drastically effect current account deficit? Yes, it is Crude Oil. The most relevant factor, that alongwith global sentiment has affected the Indian markets and reveresed the trend. Rightly called the 'Blood of the Earth' by noted writer Dilip Hiro in his book by the same name, crude oil has a direct impact at the macro as well as the micro level. Each nation needs energy for industries, transportation and to 'fuel' all the needs of people. India has always in its formative years been greatly impacted by oil prices. So much so that 2 steep spikes in oil prices in 1973-74 and 1991 led to declaration of emergency (by our then prime-minister Indira Gandhi) and erosion of our foreign exchange resources in 1991, the latter forcing us to approach the IMF for emergency assistance. This led to the dramatic economic liberalisation of our economy by then PM Narsimha Rao which continues even today and has been attributed as the significant action that sustains our 8-10% GDP growth. But the same factor has led to a decline in our indices by a huge amount due to its dramatic rise from $90 to $140 per barrel owing to increased demand, talks of OPEC nations limiting supply and price speculation. It is a combination of these three factors, no one knows where its headed and there are contrasting theories given by analysts some saying that these prices are unsustainable and would eventually fall, while some predicting oil at $200 per barrel this summer. For a country which imports crude in such huge amounts (70% of imports), the impact is more pronounced. There is an instant depreciation of the domestic currency due to oil companies paying more (in dollars) for imports and selling pressure on the rupee. Inflation increases due to the high-base effect of oil from 4.5 to 11 percent, spooking the markets. Add to that, slowing, dismal IIP numbers and expectation of a slowdown in GDP growth, declining global markets, high inflation in domestic markets, we get a negative sentiment which would take an economic miracle to reverse. FII's have been net sellers in the Indian markets ever since the beginning of the year having withdrawn $6.25 billion dollars vs $17.36 billion dollars of inflows last year, a purely profit booking move to show on their bottom-lines. Everything is in the red and return on equity is not magical like last year.
So where are we headed? According to me the Indian story remains hopeful despite all these factors in the long run. Everyone is keenly watching the price movements of oil, our maker or breaker. The government needs to exercise stricter control and raise petrol and diesel prices (in line with crude increase) so that oil companies are not severely effect. The IOC Chairman recently made a statement that it has only enough funds to supply oil at a loss till Sep '08. The Government should recognise the severity of the issue and increase fuel prices by the requisite amount to prevent oil companies from bleeding away. The Left's pressure of protecting the people from price hikes does not come into the picture here as urgent steps need to be taken to curb domestic oil demand so that our current account deficit remains in check. Mr. Karat should realise that this is for the collective good of the people in the long run. Selling oil futures to companies and increasing petrol prices by small amounts will not help. The people should understand that it is indeed a grave situation that the country is facing with respect to oil and the UPA-Alliance should stop its election-mindedness in the greater interest of the country. The recent CRR and Repo hikes of 50bps each by the RBI will reduce liquid money in the economy and thus act in countering inflation but unless oil prices decline, the situation for the Indian economy remains uncertain and it is best to play the wait and watch game.
At the end, I'd like to say that India can be compared to the old, moving elephant (paradigm used by economist Gurcharan Das) with strong fundamentals and huge value unlocking prospects. One should not mix the economic cycles with fundamentals. In the end, the fundamentals will win and reflect themselves, much like the victory of good over evil.
-Utsav Pathak

Crude Oil- The Issue

Just when you thought that subprime was going to fizzle out and the fear of the credit crunch was almost a thing of the past, you saw global crude dangerously flirting with $140 levels and a very realistic fear of US undergoing recession. It makes you wonder how the present global crisis against all odds is such a lethal combination of the credit crisis, slowdown and commodity and food price inflation. The reality seems much more connected than what we actually think. With subprime playing heavily on the American economy, the US Federal Reserve was in no position to let housing prices fall further along with much needed liquidity to bail out the ailing investment banks. The collapse of Bear Sterns would have most likely played havoc with depositors and investors and seen an overnight withdrawal of all investments and deposits. Though in the absence of the $200 Bn injection into the US financial system, a pre World War II- Great Depression like situation was almost imminent, yet the way in which the money came into the system may be argued. 

As the global and American economy was staring into the eyes of a slowdown, investor confidence in equity especially in developed world was at an all time low. With decoupling of the Asian economies also disapproved, the last thing any sensible person wanted to do was put in money into equities. Corporate debt was definitely an alternative but considering the sudden drop in sales and consequently margins and revenues, investors would any day prefer to remain at an arms length from any sort of corporate borrowings, long-term or short-term. The gradual easing of interest rates in the US was one reason for the rapid depreciation in the USD and an obvious consequence was a steep rise in the price of crude along with other commodities. Another important consideration is that the existing and newly injected money supply in the system would have to be invested in some instrument or the other and eventually it seems, most of the money lay invested in commodities. With the global economy barely growing by 3.5% in 2007 riding on the back of India and China inspite of the largest economy in the world shuddering from prospects of a recession, a modest estimate would be that oil consumption too went up in line with the growth [Though 2008 sees a forecast of oil demand rising by just 0.8%]. So has the supply really fallen since the demand has been more or less stationary? What really made oil price double in the past one year? Speculation of a fall in supply due to turmoil in Nigeria, Iran and a few other oil producing countries is said to be one of the reasons why the price of crude has really risen. However one must remember, during the American war in Iraq both at the times of George Bush Sr. and his infamous son, speculation of a supply shortfall was much stronger than what it is today. Even the discovery of massive oil reserves just offshore of Brazil couldn’t help decrease the price of crude. 

The present Bush administration seems to be cocksure that the present case of oil price is basic demand supply hike. Looks like the first citizen of America isn’t really aware of the amount of speculative capital in commodities right under his nose. With futures trading in oil going up by 100% at New York over the past year, it can be easily understood that the demand has been essentially created through artificial factors and the bubble will probably be the first victim of a resurgent world economy. Unfortunately, oil prices have a strong bearing on the global economical growth and at such high levels the economy will be tested hard to prove its resurgence. From our past experiences global economy will definitely hit back but the question is when? At this point of time an extremely likely situation of a steep increase in interest rates by Ben Bernake too cool inflation in the US would probably slow down the American economy further and delay a comeback on the industry’s part. Till the manufacturing and services industries don’t revive wages won’t increase and a rise in demand for industrial goods and services seems unlikely. Until then investor money will slowly move out of equities and seems to be safely locked into commodities. It looks like there has been selective picking and steep increases in various commodity prices. In 2007 we saw gold rallying and then it was food. Crude has slowly and steadily been rising in the past 1 year and it looks like very soon speculators will have to look for other commodities. From what it appears as of now, crude will remain stable at current levels for a certain amount of time and there will be a gradual fall in commodity prices only when we see a few good quarters by some of the big international firms and only then would confidence into equities and corporate debt be regained.

-Akhil Sharma