A spate of recent analyses in India has focused on the threat of the monsoon season to add a cautionary note to tales of the surging stock market. There is, however, more to this than meets the eye.
Up until Thursday afternoon local time last week, Indian equities had a remarkable bull run, rising nearly 20%, from 13,400 to nearly 16,000, over the three previous weeks. This spike was due largely to an inflow of foreign funds, with renewed risk appetites seeking higher returns and buoyed by the Indian market's valuations relatively lower than in other emerging markets and by decent corporate results.
In the next two-and-half trading days, the benchmark BSE Sensex 30 index plummeted, opening on Tuesday under 15,000 before recovering slightly to close at 15,074. In the first instance, this is due to foreign institutional investors booking their profits and domestic institutional investors being unable to purchase the vast quantities of shares being dumped on the market. The broader-based Nifty index has followed the Sensex's general trend, although it did not participate quite as strongly in the run-up and has not been hit quite as deeply by the sell-off.
Yet deeper dynamics are also at work. The new government's budget, announced five weeks ago, was intended (along with its first two stimulus packages) to help firms in key export sectors. The main features of these policies were to leave tax cuts in place in order to promote consumption, to increase spending on infrastructure along with public services (especially favoring rural areas), to sell off parts of public enterprises outside the banking and insurance sectors (these latter two would seek greater market penetration), and to continue credit incentives for producers of all sizes.
Within a week following the budget announcement, the stock market's benchmark BSE Sensex 30 index fell over 10% from nearly 15,000 to 13,400, the level from which the recent run-up, now ended, began. That was because these budgetary measures will not only fail to offset falling foreign demand, they will also fail to specify how the fiscal deficit resulting from these and other reforms will be reduced.
Both the Standard & Poor's and the Fitch rating companies put India's bonds at the lowest investment grade level, expressing doubts about the future effects of current stimulus policies on government finances.
Indian equity markets have shown weakness in the short term and will probably experience a pullback, but this will probably be only a prelude to further advances, as the country's resilient national economy does have better internal demand than many others in the region.
This is what is necessary to drive Asian growth in the absence of a marked recovery in Europe and North America, but it is a long-term phenomenon only beginning to evolve now. It will be to everyone's advantage that Asia develops the capacity to recycle its own capital without having to send it halfway around the world.
The decline in share prices came just as the July Purchasing Managers' Index (PMI) signaled expansion for the fourth consecutive month, remaining at its June level of 55.3. (Any figure above 50 signifies expansion, below 50 contraction.) This occurred despite imports being down nearly 30% in June from the previous year after being down nearly 40% in May year-on-year.
The overall decline in exports began last October, although China's government stimulus helped primary commodity exports. Thus part of India's PMI growth has been due to restocking, as in China, but consumer spending has also been picking up, mainly due to the government's policies of fiscal and monetary stimulus, including infrastructure spending.
However, employment has not picked up at a matching pace, and job losses continue to be registered. From September 2008 to the end of January, job losses reached nearly 1 million in export sectors.
The Reserve Bank of India (RBI) maintains a gross domestic product growth forecast of 6% for 2009-2010. The composite consumer price index was in double digits for the first three quarters of 2008, but has now stabilized around 10% year-on-year. The real interest rate declined from 7.7% at the start of 2008 to just over 1% at the start of 2009 before rising again to over 3% and settling back in May to just over 2%. A recent research note of the Indian Council for Research on International Economic Relations on the subject concludes that high inflation and low real-interest rates justify the RBI in keeping policy rates unchanged.
Growing domestic demand has so far offset decreased, although recovering, foreign demand. Industrial production rose the fastest in eight months in May, the latest month for which statistics are available, growing 2.7% year-on-year, and led by domestic demand in mining, electricity and manufacturing. Even in the last quarter of 2008, overall output was up 2.4%.
The construction sector has also contributed. Yet even if core industries have generally been improving since the end of the first quarter of the current year, India still risks participating in an all-Asia trend towards overproduction through export subsidies, a trend boding ill while the world economy as a whole already has excess capacity.
For the time being, foreign investors will focus on whether the Sensex will in the near term penetrate below its 13,400 support level. There is still an unfilled gap-up from 12,200 from the middle of May, when share prices reacted favorably to the Congress Party's unexpectedly strong success. Any weakness in world prices for industrial commodities could easily lead to that gap being filled.
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First published by Asia Times Online, 13 August 2009.