Stock market under stress

December 19, 2011

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The first big jolt to the market after the 2008 crisis had come last August when FIIs disinvested 95 billion rupees worth of equity and moved into liquid assets. That brought the Sensex down by 1500 points and pulled the dollar up by 4 rupees.

The FIIs wanted to reduce their risk which had been heightened by the EU crisis. It was not Greece alone but even Italy, the third largest European economy, which was in danger of sovereign debt default. These governments could borrow only at interest rates over 7 pct, about 2 pct more than the average rate for EU countries.

Undoubtedly, the prospects for the Economic and Monetary Union (EMU) were grim and there could have been sheer chaos had a weak state like Greece or a strong state like Germany left the Union. France and Germany did finally persuade other members to accept fiscal consolidation and establish a permanent bailout fund. An early agreement failed mainly because of the veto exercised by Britain. Hence, a new treaty will have to be signed which is not likely before March.

The promise of a new treaty was not enough to create confidence among investors in the solidarity of the EU or the European banking system. For that reason the recovery of world markets did not come through. The BSE Sensex hardly changed its mood and, with the added fear created by the 5 pct fall in industrial production, declined further.

There were triggers that could have kicked up stock prices. A good opportunity for market recovery was lost when the government almost withdrew the earlier amendment to facilitate FDI in retail. With a fractured parliament and undependable allies, it is unlikely that any major reform will come through before the elections in Uttar Pradesh.

The next budget can be a trigger but is unlikely to be one. For, the kind of pressure under which it is at present requires the finance minister to seek approval to borrow another 550 billion rupees, mainly to fund subsidies. As such, it may be difficult to even maintain the fiscal deficit at 4.6 pct as provided in the last budget.

Perhaps the only stimulus could be the DTC. But it would be too weak to promote a strong market recovery.

The RBI has now realised that its monetary policy has gone a little too far and a reversal is desirable. A reduction in repo rate can be expected but only at the next policy review. However, there are indications that industrial growth may pick up. Car sales have gone up 7 pct in November and HSBC’s PMI jumped from 50 in October to 53 in November. While these are good signals, market recovery does not appear to be round the corner.

The resolution of the EU crisis appears to be the major factor likely to help the market to come into its own. In addition, if the RBI reduces the repo rate by 2 pct in the first quarter of 2012, a healthy recovery of the market is possible after March.

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