Indian markets at risk but elections could spell change

September 17, 2013

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

It’s been an eventful September so far for India. The Indian parliament cleared key economic legislation in its extended session. The Reserve Bank of India saw a new governor taking charge. FII flows reversed trend to turn positive in equity and debt markets. Volatility in the currency market subsided and the rupee staged a recovery from historic lows. Near-term bond yields shrank and the August trade deficit came in lower as exports climbed. The Syrian crisis seems to have abated. Does this mean that the worst is behind us and things will start improving?

As discussed in my previous column, some of these actions from the Indian government and the central bank seem like quick fixes to set right deteriorating macroeconomic numbers. India’s Q1 GDP is now at 4.4 percent, much lower than expected, and FY14 GDP growth is expected to be below 5 percent. The rise in interest rates on account of the central bank’s measures to lessen currency volatility will definitely affect GDP growth in the remaining three quarters. Monthly IIP and PMI numbers are not encouraging either. Both WPI and CPI inflation are not yet stable. Headline inflation soared to a six-month high in August. Input costs for the consumer staples basket are set to rise due to currency depreciation, which could have an impact on consumption volumes. On the oil subsidy front, rupee depreciation has again increased per unit under-recovery on diesel, kerosene and cooking gas. The urgent need for a substantial increase in diesel prices could eventually have a dampening impact on growth.

The equity market volatility index has risen despite markets moving up and may indicate that near-term volatility will continue. Before the end of September, there would be more information on the probable withdrawal of QE measures by the U.S. Federal Reserve.

With the monsoon session of parliament over, the political focus would shift to state elections this year that would set the stage for general elections due in 2014. Government spending, which has been curtailed so far to reduce the fiscal deficit, may see resurgence. This could give some support to sagging GDP growth in the second half of FY14. The markets may not cherish any populist announcements ahead of the elections.

Although export-related sectors of the economy would stand to benefit, it remains to be seen how hedging could have reduced this impact. The banking sector would continue to have its problems with non-performing assets. One needs to monitor banks, both public and private sector, that have grown above the industry average growth of 16 percent on average over the past three years. Valuations in the consumer and pharmaceuticals space appear to be stressed unless backed by strong top line and earnings growth in the coming quarters.

Market valuations on a fundamental basis seem to have been dented due to the slowdown in GDP growth. But robust FII flows this year have balanced the Indian equity markets valuation. This puts the market at risk in the event of a reversal of flows with global liquidity tightening. Having said that, India’s economic milieu could change for the better after the general elections.

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