The BSE sensex gained just under 30 per cent in 2017, ending the year at 34,056. This was primarily due to the money flow from fixed income (largely bank deposits) into mutual funds as retail investors discovered the inability of banks to protect them against the erosion of money-value through inflation and the risk of a newly-legislated bail-in provision becoming a reality.
In a ‘bail-in’, it is the depositor funds that are forfeited by a failing bank, as opposed to a ‘bail-out’ where the government brings in funds to rescue it. In other words, the risks of poor lending by the bank are assumed by the depositors. Insurance only protects a piddly ₹1 lakh of fixed deposits, a figure that has remained unchanged, even as salaries and perks of MPs are continually linked to inflation.
Long bull-marketThanks to the huge transfer of funds from fixed income into equity, largely via mutual funds, stock markets have been on a roll.
There is, yet, a mountain of funds awaiting similar transfer and, in a perfect world, the Indian bull can run for a very long time indeed, fed by this money flow.
But we do not live in a perfect world, and investors must assess what risks could slow down, or temporarily derail, the raging bull. There are three macro economic factors to keep an eye on.
Current account deficit: Crude oil prices had fallen, providing great relief to a country which is a big importer of it, thereby bringing down India’s current account deficit to less than 1 per cent of GDP.
Crude oil prices are now rising, and have gone up 20 per cent year-to-date, to $66.57/b. This will place a severe strain on the current account deficit, and thus, on our exchange rate, as also on the fiscal deficit.
Threat to the current account deficit will also come from the changes being made by the US in the H1B visa regime, which could send back five lakh IT workers (thus reducing IT exports and inward remittances). The IT sector is one of the largest providers of jobs, backed by exports; this would be impacted.
Fiscal deficit: The Budget had put the fiscal deficit target at 3.2 per cent of GDP for the current year. This level has already been breached in November. GST collections are lower than forecast. Economists expect the deficit to be 3.5 per cent by the end of the year.
In 2018, the fiscal deficit could come under severe strain if only because with 2019 being a year of General Elections, the temptation to spend taxpayer money in populist schemes would be great.
The CAG has pointed out that the government has presented a better fiscal deficit picture by simply postponing payment of ₹1 lakh crore in subsidy payments for food and fertilisers. So, the true picture of fiscal deficit is already bad.
Inflation: Rising crude oil prices, populist expenditure before the general elections, weakening rupee, and paucity of jobs will result in higher inflation. If it rises fast, banks would raise interest rates, thus slowing the money flow from fixed income into equities.
The US is already in an interest rate increase cycle. It can be expected that ECB, Japan and China may also reverse easy money policies.
(The writer is India Head — Finance Asia/Haymarket. The views are personal.)