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Straight from the Specialists

India Market Weekahead – Volatility to continue in the run-up to general elections

By Ambareesh Baliga
August 18, 2013

(Any opinions expressed here are those of the author and not of Thomson Reuters)

Investors pressed the panic button on Friday with the Nifty diving 4 percent, its biggest single-day fall in two years, to end at 5508.

Measures taken by the Reserve Bank of India (RBI) on the eve of the Independence Day holiday to prop up the rupee were among the triggers for the fall. The rupee didn’t do all that well either, falling to an all-time low of 62.03 to the dollar early on Friday.

Recent policy actions have backfired, with markets fearing that the announcement of ad hoc measures could further undermine the confidence of foreign investors.

Macro numbers during the week also showed a declining trend. Industrial production contracted 2.2 percent in June. The trade deficit in July remained high at $12.27 billion with inflation powering along at 9.6 percent. With the rollout of populist measures such as the food security bill, I wonder how the finance minister will achieve his deficit targets.

The tables have turned. Emerging markets, especially India which was in an enviable position in the aftermath of the Lehman crisis of 2008, are struggling today while developed economies such as the United States and euro zone are showing signs of recovery. This could lead to the tapering of U.S. stimulus, further affecting flows to emerging economies.
India seems to be moving from one crisis to another. The big dilemma for the incoming RBI governor would be how to get the economy back on track with growth measures that don’t affect the rupee. The tools Raghuram Rajan has are liquidity and interest rates, which will rock either growth or the currency.

The biggest fear today is that the concoction of high inflation, spiralling interest rates, a depreciating currency, a slip in manufacturing sector growth and below par GDP growth expected for the current year could lead to stagflation.

India’s benchmark 10-year bond yields surged to 8.88 percent on Friday, leading to mayhem in the bond market.

Investors have lost a good portion of their gains from debt mutual funds in the last few months. The focus is now shifting from returns on capital conservation. Yields have been rising in the U.S. markets, another reason for the outflow of FII funds from the bond markets in India.

On Aug. 21, the Federal Open Market Committee (FOMC) will issue the minutes of the July 31 meeting, which could throw some light on the U.S.  Fed’s bond buying plans. This would affect sentiment in the emerging markets.

Friday’s drastic fall was followed by soothing statements from Prime Minister Manmohan Singh as well as the finance ministry that there was no question of a repeat of the economic crisis of 1991. There are no plans to revisit capital remittance controls for foreign investors. This could result in a mild recovery but I don’t expect a sustained one as the government doesn’t seem to be in a position to provide a long-term solution.

I also don’t expect more inflows till elections due in 2014, unless the central government shows signs of stability. Volatility will continue in the markets and as I mentioned last week, we will see a few shocks in the run-up to the elections.

The markets could bounce back to 5650 which should be utilized to lighten positions. If 5500 levels are broken decisively, it will open a new range for the markets towards 5200. It would be best to maintain a high level of liquidity for distressed investment opportunities which would arise in the next few months.

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