The Hindu Business Line : Mere blips or serious dips?

The past couple of months have seen stock market players swing from shock and pessimism to business-as-usual, with the indices correcting sharply before staging a recovery. With so many developments to mull over, opinions were, as usual, divided across market-watchers. Here are some optimistic and pessimistic views on key developments:

Hike in Cash Reserve Ratio

The RBI finally stepped in to address the issue of excess liquidity by hiking the cash reserve ratio (CRR) by 50 basis points to 5.5 per cent in two stages (December 8 and January 7, 2007), sucking out about Rs 13,500 crore from the banking system. The move is to check inflation, which is hovering well above the 5 per cent mark.

Point: Some analysts feel that the era of cheap money is over. Already, the majority of banks have hiked their prime lending rates, which could squeeze the excess liquidity chasing assets such as equities and property.

Counterpoint: The move may not make a significant difference to liquidity. Though the increased CRR could impact banks' profit margins, there is enough excess liquidity to keep the market moving.

IIP worries

The October quick estimates of the Index of Industrial Production (IIP) from the Central Statistical Organisation (CSO) came as a surprise to many. Industrial production growth dipped unexpectedly to 6.2 per cent in October after recording remarkably high growth rates of close to 10 per cent for the first six months of the financial year.

Point: This is only the tip of the iceberg. The overheated economy could see further cooling off on the back of higher interest rates and inflation.

Counterpoint: It is not appropriate to read too much into numbers for a single month. The timing of the Diwali sales and the holiday season in October this year, instead of the usual November, may have caused the blip. Nothing is wrong with the economy and next month's IIP numbers will bear this out.

High market valuations

The BSE Sensex is quoting at a forward price-earnings multiple of about 18 times and a trailing multiple of about 23 times earnings.

Point: Indian valuations are stretched and the BSE Sensex is trading at a significant valuation premium to other emerging markets. There are several opportunities outside of the Indian market, available at cheaper prices.

Counterpoint: Though the valuations seem stretched, the quantum of funds waiting to enter India is huge and with robust fundamentals and one of the strongest growth rates, India still looks attractive for long term.

US Slowdown

US economic numbers, as well as indicators such as housing starts and industrial production, suggest a slowdown.

Point: The US economy, which is witnessing stagflation and showing signs of weakening further, could pose a threat to the global equity markets.

Counterpoint: the Indian economy and its companies do not rely too much on the US for growth. As India is relatively insulated from happenings in the US, there will be no significant impact on liquidity flows.

Thailand's policy flip-flop

Thailand imposed restrictions on foreign investments which required that investors retain all sums not linked to trade or foreign direct investment within Thailand, for at least a year. This move forced a 17 per cent decline in the Thai stock market and a sharp reversal in the Thai baht, the strongest Asian currency this year.

Point: This move could make FIIs more cautious about allocating funds to the emerging markets, including India, as several countries with appreciating currencies could use such measures to improve their export competitiveness.

Counterpoint: It is unlikely that other countries will adopt this strategy, as this could be counterproductive. That fact that Thailand had to reverse these moves and exclude equity investments from its restrictions could serve as a deterrent to others.

Weak commodity prices

The prices of crude oil, gold and select metals have retreated from their peaks.

Point: Weak commodity prices are a precursor to similar trends in equity market. With increasing cross-border investments and investors moving between asset classes, the weakening of one asset class in the portfolio should impact other assets too.

Counterpoint: Weaker commodity prices may ease margin pressures on companies and bolster earnings. As to allocations, even if commodity prices decline further, the funds originally slated for commodity investments will be reallocated to other asset classes, particularly equities.

K. S. Badri Narayanan

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