Expert Zone

Straight from the Specialists

Forget 2011, and gear up for a challenging 2012

By Ambareesh Baliga
December 31, 2011

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

Everything that could have gone wrong, did, and our policy makers literally snatched defeat from the jaws of victory. This is something that summarises the Indian economy and the stock markets for the whole of 2011.

Inflation, falling industrial output, high interest rates, scams, weak rupee, policy logjam, foreign fund outflows, high commodity prices, euro zone debt crisis and so on weighed on the stock markets. The benchmark indices lost 25% in 2011, with India remaining the worst performing market this year.  This is its second worst performance in 14 years, after 2008 when the U.S. financial crisis struck.

In 2011, foreign fund inflows dried up with net outflows of about $500 million, as compared to record inflows of more than $29 billion in 2010 and $19 billion in 2009.

We started the year with a decently strong growing economy, international investor interest and a stable currency. Though inflation and interest rates were on the way up, it was expected that these ills will get controlled post monsoon and would be absorbed by a growing internal consumption economy. The commodity prices were expected to correct looking at the slow down and problems being faced in the euro zone and the U.S.

Among our peers, we were supposedly the least affected due to our consumption pattern and demographics. We could have utilised the opportunity to move to the next level of growth but the only joker in the pack was continued government inaction and a limbo in reforms process.

Inflation clearly remained the biggest and most engraved concern for India this year. Soaring prices of food and essential commodities compelled the Reserve Bank of India to raise rates 13 times in a row totalling 300 basis points.

Rising interest rates had its repercussions on industrial production (IIP) as investments into capital intensive sectors got impacted. The data for the month of October contracted to -5.1% which was by far the worst and was the first decline since June 2009. Production of capital goods fell sharply by 25% which dragged most capital goods stock valuations below the 2008 levels.

As if economy strains and business cycle pains were not enough, the outbreak of various scams involving top government officials dampened the market sentiments even further. The most high profile scams were the 2G scam followed by the mining scam.

The withdrawal of the proposed 51% FDI in multi-brand retail after stiff obstruction from government’s key allies, including Trinamool Congress and DMK, was the final nail in coffin. This regulatory and reforms uncertainty remained a major source of concern to investors.

The Lokpal bill standoff also undermined whatever reputation was left of the tottering UPA government which was pushed to a corner on corruption charges.

The rupee touched a life-time low falling 17% to Rs. 54.17/dollar on sustained foreign capital outflows and strengthening of the dollar against most currencies The weakening rupee added to the inflationary pressure and is a severe setback for corporate India as it would mean higher interest rate outflow and repayment liability on its foreign currency debt.

Internationally, the euro zone debt crisis remained the biggest business story of 2011. The crisis deepened as the trouble that started with Greece spread to Italy, Ireland, Portugal, and Spain and speculation mounted about the collapse of the euro zone. European leaders have still been unable to reach a consensus on how to solve the crisis which remains the major demon as we enter 2012.

India cannot stay immune to the deteriorating situation in the euro zone.

Outlook 2012

Reforms and policy action could be the catalyst in the year ahead, though it will be a tightrope walk for the policymakers and the RBI. Introduction of GST, FDI in multi-brand retail, FDI by foreign airlines and power sector reforms will be in spotlight. The Food Security Bill, which is most likely to be cleared, will lead to higher fiscal deficit of $30bn.

The budget session will the last tool for the government to push reforms, though the markets are not expecting much looking at the pro-populist mood.

The Q3 results to be announced in January could be disastrous but the saving grace could be inflation which is subsiding; though due to high base effect. And this will be positive for our markets as it will pave the path for the RBI to cut rates from the second quarter. This could act as a trigger for a revival in the investment cycle. The GDP growth will continue to weaken in the short term. However, India has the ability to bounce back on the growth track once the policy environment improves.

 

It’s an election heavy year with Uttar Pradesh in February followed by Gujarat in April. In case the ruling UPA manages to wriggle out a better performance, which most of us doubt, this could be one of the triggers for them to push through some of the reforms.

Possibility of a full blown recession in euro zone is quite high and thus concerns emanating from this part of the whole will keep markets extremely uneasy and volatile.

Though 2012 will be challenging, it does present an opportunity to build a portfolio of quality blue chips which are available near their March 2009 valuations and the Sensex P/E is trading below its long-term average which is unusual to sustain. The markets have priced in the concerns and headwinds. Though it is difficult to put a target level for the key indices, I expect Nifty to touch levels of 5,600- 5,800 in the coming year after touching a low of 4,200 in the first quarter of 2012.

The depressed sentiments and low expectations will pave way for optimism on any signs of turnaround in the economic situation. I believe that the “survival instinct” would play out among all the stakeholders of the economy, which could help bring it back on track.

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