Is the Indian Market's Bull Run Under Threat?

Sep 10, 2018

Ankit Shah, Research analyst

What happened?

The Sensex came within touching distance of the 40,000 mark towards the end of August, hitting an all-time high of 38,990 on 29 August 2018.

But since then, the markets have witnessed bouts of nervousness. This, despite the fact that India's GDP is estimated to have grown at 8.2% in the quarter ended June 2018 and corporates have shown signs of earnings revival.

So, what's worrying the markets right now?

At the domestic level, India faces worsening current account deficit owing to rising oil prices and the strengthening US dollar.

Let me explain in very simple terms why the current account deficit concerns you.

The current account measures the flow of goods, services, and investments in and out of an economy. India has traditionally been a net importer goods and, hence, runs a current account deficit.

Why is the current account an important macro variable to look at? It impacts the value of the currency. If the current account deficit gets wider, the currency bears the brunt of it. That's exactly what has happened...

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During the financial year 2017-18, India's current account deficit (CAD) stood at 1.9% of GDP. That was a significant jump from a CAD of 0.6% in 2016-17.

And given the case of rising crude oil prices and strengthening US dollar, India's current account deficit is getting worse.

As you know, India imports about 80% of its oil requirements. Our total import bill of crude oil and petroleum products stood at a little over US$ 100 billion during the financial year 2017-18. That's about 4% of India's GDP.

During the same year, India's trade deficit jumped to a five-year high of US$ 160 billion (increase of 42% year-on-year). A trade deficit is a situation wherein imports exceed exports.

This gives us a fair sense that crude oil imports have a substantial impact on India's current account.

With international crude oil prices close to US$ 80 per barrel again, it's a matter of worry for import-dependent economies like India.

India's total import bill of crude oil and petroleum products for April-July 2018 was US$ 44,363 million, registering a jump of 55.6% year-on-year (See more in the Chart of the Day section).

The troubles for India are further accentuated by the strengthening dollar, as the USD-INR exchange rate collapses to a new record low of above Rs 72 per US dollar. It means that the import bill for India is set to get more burdensome.

India's current account deficit has further deteriorated because of the exodus of foreign investors from the Indian capital markets.

Look at this table...

Investments in Capital Market by Foreign Investors (FIIs/FPIs)

Month Total (Rs m) Debt (Rs m) Equity (Rs m)
Apr-18 (183,155) (118,683) (64,679)
May-18 (274,659) (177,508) (96,599)
Jun-18 (135,738) (110,016) (25,773)
Jul-18 20,957 7,178 14,292
Aug-18 3,029 23,668 (20,288)
Net Inflows/(Outflows) April to August 2018 (569,566) (375,362) (193,046)
Data Source: CMIE

Between April and August 2018, foreign investors have sold Rs 569.6 billion worth of equities and debt instruments.

How is it then that the Indian stock markets have not witnessed a major sell-off? The reason is the flood of domestic liquidity that has kept the Indian markets buoyant in the face of the exiting foreign investors.

My other concern is that rising crude oil and the depreciating rupee could also have an adverse impact on the fiscal deficit.

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Now, you may point out that petrol and diesel prices are deregulated. Then why would rising crude prices hit fiscal deficit so long as the Government keeps on passing the increases in crude prices to the consumer?

As far as petrol and diesel prices are concerned, it's true that the prices of these fuels have been deregulated. The government doesn't subsidise them like before, and hence, doesn't have to bear the burden of rising prices.

But here's the trivia... Not all petroleum products are deregulated. Liquified Petroleum Gas (LPG) and kerosene are still regulated and subsidised. In the Fiscal Budget 2018-19, the central government had budgeted LPG subsidy of Rs 20,377.8 crore and kerosene subsidy of Rs 4,555 crore for the ongoing financial year. So, the total budgeted petroleum subsidy for the fiscal year has been Rs 24,932.8 crore, budgeted at 0.5% of government expenditures.

Given the rise in international crude oil prices and the additional impact of a falling rupee, this subsidy bill is set to go up.

So, even if the government doesn't cut excise on petrol and diesel, rising oil prices do have an impact on the fiscal deficit.

In fact, ratings company Moody's Investor Service recently published a report stating the central government is likely to miss its fiscal deficit target in 2018-19 due to higher than budgeted oil prices and rising interest rate scenario. It must be noted that the government has set the target of reducing fiscal deficit to 3.3% of GDP in 2018-19 from 3.5% of GDP in the previous fiscal year.

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So, will the government cut excise duty on petrol and diesel?

It has been recently reported that one of the top finance ministry officials has said that the government will not cut excise duty on petrol and diesel as it has limited fiscal space available to take any dent in revenue collections.

In that scenario, there is a risk that higher fuel prices will set the inflation meter rising beyond the RBI's comfort range of 6% and prompt it to increase interest rates.

Higher interest rates are the enemy of corporate profitability and capital investments. Higher fuel costs also result in higher operating costs, denting profitability of companies that are vulnerable to oil prices and rupee depreciation.

This predicament comes at a time when Indian corporates have just started to witness growth in earnings.

So, will crude oil and rupee play spoilsport to the Indian bull run?

I don't think we should jump to quick conclusions and try to second-guess the markets. Because while these factors are a net-negative for the Indian economy, there are certain sectors and companies that tend to benefit from these trends. The IT sector being one example.

The fourth bi-monthly monetary policy statement for 2018-19 is scheduled to be presented on 4 October 2018. I'm going to keep a watch and see how the macro picture evolves in the coming days and months.

The most important thing you must remember is that this is not an ordinary year, it's an election year. So, it will be interesting to see how the Modi government balances between taking steps to gain political mileage and addressing the emerging economic challenges.

In the meanwhile, I'll continue delving into these macro issues and gauge their impact on the stock markets. For more insights and investing ideas, join my premium newsletter Insider now...

Chart of the Day

I've been writing about the threat of rising crude oil prices since May 2018. (Alert: Narendra Modi's Best Friend Is Stabbing His Back Right Now)

In May 2014, when Narendra Modi took charge as the Prime Minister of India, crude oil prices had been firmly above the US$ 100 per barrel level.

But as luck would have it, crude oil prices started crashing right after Modi came to power. Between May 2014 and January 2016, crude oil prices crashed 74%.

This gift of lower crude oil prices was the biggest boon to the Modi government.

The sharp drop in crude oil prices corresponded with declining inflation. This, in turn, allowed the RBI to lower interest rates.

Such a benign inflation and interest rate environment was ideal to revive the investment cycle and the economic growth engine. The Indian stock markets gave a thumbs-up to these favourable economic factors.

But now, just when the economy is on the verge of revival, Modi's 'best friend' is betraying him. Crude oil prices are rising.

Today's Chart of the Day shows India's crude oil and petroleum products import bill for the period April to July over the last four years.

Crude Oil Bill Jumps 56% in 2018

You can see that the crude import bill was substantially lower in the April-July period of the previous three financial years. In the latest financial year, however, the import bill has shot up 55.6% year-on-year.

And it is hardly any wonder that the rupee has been tumbling lower and it currently at a life-time low against the US dollar.

Given we're in an election year, it will be interesting to see how the government responds to these economic shocks and how market participants react in the stock markets.

Happy Investing,

Ankit Shah
Ankit Shah (Research Analyst)
Editor, Equitymaster Insider

PS: Every day the markets are open, Ankit Shah, editor of Equitymaster Insider, cherry picks one investing idea from our 8 premium publications. This is the one idea that he considers to be the best moneymaking opportunity in the market. He shares this idea with an exclusive group on his 'insider list'. To join this exclusive group of insiders... click here..

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