This week Dalal Street is likely to go in for a sharp fall if the US Federal Open Market Committee (FOMC) does not indicate start of quantitative easing or QE-3 in the near future. The US Federal Reserve's action this Tuesday — when an FOMC meeting is scheduled — will direct global liquidity flow in the short term.

Emerging markets, according to observers, are likely to witness serious withdrawals by overseas investors as both the FOMC and the US Federal Reserve may not clearly signal a fresh bout of pumping of money into the financial system at this moment.

But local equity market needs a leader to take it out of the current drift. Operators are not in a position to provide that leadership. However, if the clues from the US can someway be read as positive, the Dalal Street players may have the heart to ignore the European crisis.

The Wall Street response to the global economic slowdown also has a bearing on the medium-term outlook of the local market. India remains highly dependent on non-FDI capital inflows to fund its current account deficit. Even a short-term withdrawal of FII money may cause a domino effect.

According to Morgan Stanley economists, since the credit crisis India's current account deficit has remained high, as the Government has run down its savings. There was a rise in the share of net FDI in total capital inflows to 52 per cent in 2009 due to the rise in FDI inflows as well as a decline in non-FDI inflows. This trend again reversed in 2010 as FDI inflows declined and non-FDI inflows rose.

The share of FDI inflows dropped to an unusually low proportion of 16 per cent compared to 55 per cent in China and 37 per cent in Brazil in 2010. What Morgan Stanley economists in their recent note on India do not point out is the link between FDI flow and quantitative easing after recession.

But the note says that just as the global environment improved in the last quarter of 2010, domestic factors such as corruption-related investigations and the rise in inflation and cost of capital have held back the investment cycle.

Macro headwinds — risk of inflation and cost of capital remaining higher for longer — are affecting the domestic demand outlook. “They could continue to hold back foreign investors over the next six months.”

Citi note said there could a bit of caution over the next one to two quarters on growth, margins due to higher inflation and rate environment. “But there appears little caution if you look beyond; almost no guidance revision, no changes in investment plans, no real talk of strategy change or business restructuring or review of the fundamentals or longer-term India story. While investment heavy sectors are guiding to back-ended growth (more hope than necessarily fact based) with regulatory approvals the primary challenge – the overall view is one of a cyclical challenge, rather than a structural problem,” the note added.

> jayanta_mallick@thehindu.co.in

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