Can harsh economic realities derail the markets? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Can harsh economic realities derail the markets? 

A  A  A
In this issue:
» Government faces hurdles in the power sector
» Fresh proposal mooted to import coal for power plants
» Can export curbs on food products contain inflation?
» Will US and Libyan output keep a lid on crude prices?
» And more!

It is indeed safe to say that the euphoria around the BJP's election victory has been tempered. The new government has certainly pushed through some reform measures and cleared a few long pending infra projects. However, it has not really covered itself in glory in its first one and a half months. The union budget too left many disappointed. While there were a few positives in the FM's speech, it left a lot to be desired. The budget lacked vision and there was no clear long term planning. Thus folks on Dalal Street have begun to look around for other triggers that can push the markets higher. Unfortunately, the bulls have hit a wall, at least in the short term. Reality seems to setting in slowly. Market participants are waking up to the uncomfortable economic situation that the country faces. We are referring to the rainfall deficit.

Here are a few disturbing facts. The monsoon has been 43% below normal so far. It has failed to revive so far in the month of July as per the met department's expectations. In the 400 odd districts in India where Kharif crops are planted, only half the area available for sowing (about 25.66 m hectares) has been covered. This is 35% below normal and down nearly 80% since last year. The production of crops like rice, pulses, oil seeds, coarse cereals and vegetables are likely to be badly hit, if the situation does not improve. What is more worrying is that state governments have begun advising farmers to shift to alternative crops. This would only aggravate the food supply situation. While we do not want to sound pessimistic, there can be no doubt that the specter of drought is now a real possibility this year. It is important to note that in 2009 (the last drought year); food inflation had rocketed to 20%. Since then, food prices have remained stubbornly high and this has kept interest rates high as well.

Apart from the severe impact that a drought will have on agriculture and rural incomes, there will be a spillover effect on hydro power generation as well. At a time when various parts of the country are in the grip of frequent power cuts, this does not bode well. Take the situation in south India for example: Out of the 30 major water reservoirs, the shortage in 27 of them is greater than 40%. A large dam in Andhra Pradesh has already run dry. This has led to a serious power deficit in south India. The burden of bridging this deficit will fall on other regions of the country which may not be in any position to do so. This is a clear red flag for the new government. We believe the power deficit scenario in the country must not be underestimated. Without adequate electricity, industrial production is bound to be badly affected. Industrial activity is already sluggish. It could do without a fresh crisis at this time.

So will these factors halt the market rally? The markets had run up a lot based on high expectations from the Modi government. Thus if the government can meet these expectations with good reform measures over the coming months, the markets are likely to remain happy. But this is no way to go about investing we believe. Ignoring harsh ground realities in the hope of better days to come is not a good long term strategy. Also, the Indian markets are driven by FII flows and not by domestic investors. Thus in the short term, events in the developed world and the Iraq crisis will play an important role along with the India's domestic woes. Investors would be well advised to remain focused on the long term fundamentals of businesses as well as the economy. By factoring in the risks faced by the economy, investors can avoid overpaying for stocks that might be impacted by the same.

Do you think the markets have ignored the harsh realities facing the economy? Let us know in the Equitymaster Club or share your comments below.

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02:10  Chart of the day
It's funny the way it is. The stock markets were downbeat about the previous UPA regime during the latter part of its rule. The markets were thus doing badly and the low stock prices created as a result inhibited the government from using the disinvestment route to bring down the fiscal deficit. This further spoiled the mood.

Now that the markets are happy about the new NDA government, stock prices are much higher. And these heightened hopes of the market are in themselves contributing towards them being fulfilled. The government has in the budget targeted Rs 634 bn worth of share sales in PSUs like Steel Authority of India (SAIL), Oil and Natural Gas Corporation Ltd. (ONGC) and Coal India. The robust markets make it likely that not only will the share sale be able to happen more easily, but also that the government will be able to fetch much higher prices for the same. This will surely help the government on its way to bringing down the fiscal deficit. Indeed, the government is already planning to hold road shows this month in a bid to woo foreign investors to participate in the disinvestment of SAIL, which may be the first off the block.

Will the target be achieved this year?

Power for all by 2019 is what the incumbent government proposed in its poll promises. And the new government is harnessing innovative ideas like the use of solar power so as to not miss the same fate as its predecessor. However, considering India's reliance on thermal power, it needs to take some quick steps in order to eliminate roadblocks in this area too. The key factors which impacted thermal capacity in the past include fuel shortages and environmental issues. It seems that the new government is committed to resolving them. Giving Coal India a go ahead, in its first project that got clearance in about five years, will act as a new lease life to coal starved plants. This is not to mention a series of clearances that the government has effected in the environmental domain.

Thus, it appears that the new government is on the right track when it comes to resolving the power crisis. However, about 400 m people in India lack electricity. And it won't be an easy task to meet the energy needs of all. It would be interesting to see how the Modi government does that.

Ever since it came to power, the NDA Government has faced a peculiar dilemma in sector after sector. The dilemma is whether to continue with the left of centre policies or break away from the past and be more free market in its approach. The power sector is a case in point. It is a well known fact that there are a lot of power plants in the country running at 50-60% of their capacity. This is because power produced there is not finding a lot of takers on account of the high cost of imported coal.

For the time being though this problem can be solved by pooling imported coal with domestic coal. What will also work in the producers' favour are the current low international prices of coal. However, this is not an optimal long term strategy. Once international coal prices go up, it could be back to square one. The only viable alternative seems to be to link domestic prices with international prices so that investments take place in the coal sector. But this will also mean higher cost of power going forward. Therefore, it will be interesting to see whether the Government bites the bullet on this one.

Worry over food inflation has been the biggest stumbling block for the Modi government ever since it came into power. The erratic monsoon compounded the worries as the food storage mechanism in the country is already in shambles. Plus with problem of hoarding, prices of products like onion have risen despite record output. PM Narendra Modi's earliest action against inflation was to curb export of essential commodities like onion and potato. While this may increase domestic supplies temporarily, it is unlikely that the price rise problem will be tackled for good. And those hoping for a relief on interest rates front with lower inflation are surely set to be disappointed. The RBI has made it amply clear that it will look for cues of sustainable control on price rises. Hence sporadic measures like banning export etc will hardly help. Food price concerns are here to stay in the medium term and the RBI may not want to relent on interest rates until then.

Crude prices are notorious for being volatile. Quite often the geopolitical disturbances in one or the other key oil producing nations, especially the members of the OPEC has thrown global energy equation out of balance. With OPEC accounting for major supplies for oil, the response is quite natural. The body has often been accused of cartelization and operating in a manner to make the most of oil prices with least regards for the global energy needs. However, with other regions, especially North Africa and US coming up with their own supplies and shale gas revolution, the supremacy of OPEC has taken a blow. Take the case of recent turmoil in Iraq - the second biggest producer in OPEC and impact on oil prices. The violence in Iraq has sent Brent crude prices to highest levels in 9 months on supply disruption concerns. However, the impact could have been worse if not for the huge increase in US production. Further, this time, the consensus suggests softening in crude prices as US and Libya is likely to make up for the shortfall.

However, this doesn't take away the concerns on expected increase in oil prices. This is because if other OPEC members refuse to cooperate with regards to supplies, US alone is unlikely to cope up. Further, in oil markets, prices are more governed by speculations than fundamentals. Hence, any further adverse development may lead to oil price shocks. And India, being a key importer of crude oil, will be one of the worst hit victims of such an event.

In the meanwhile, the Indian stock markets pared losses but continued to trade negative in the post noon trading session. At the time of writing, the BSE-Sensex was trading lower by 9 points. Majority of the sectoral indices were trading in the green led by power and capital goods stocks. Consumer durables and IT stocks were the biggest losers. Most of the Asian indices were trading in the green led by China and Japan. European markets have opened the day on a strong note.

04:50  Today's investing mantra
"When stocks are attractive, you buy them. Sure, they can go lower. I've bought stocks at $12 that went to $2, but then they later went to $30. You just don't know when you can find the bottom." - Peter Lynch
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2 Responses to "Can harsh economic realities derail the markets?"


Jul 14, 2014

Govt is unable to control prices. But, by keeping intrest rate highe, Govt is killing the industry. It is better one in hand, than two in bush.


Umesh M

Jul 14, 2014

The countries problem cannot be solved in budget proposals or FM's speech. There are many problems plaguing this country. These are as below: 1. Indescriminate use of quota (backward, caste based etc.) for political benefits; 2. Mindless populism (food security such as Rs. 2 per kg rice etc.)3. Improper use of resources (such as repair of roads, pavements etc. again and again (every year)resulting in wasteful expenditure, 4. Very bad education policy (students given pass marks without they having any knowledge whatsoever), 5. Lack of technical skill among youth (in one interview for accountants post out of 100 interviewed not even 5 had reasonable knowledge of accounts (all BCOM graduates) and no one could be appointed). No finance minister can change this. I think the Government has started well. Some of the proposals are good. My only wish is our entire system should be thouroughly overhauled and quota system is used only for eligible and should never be used as right. Education should be for all but quality is the criteria - identification of skill is the need, training of teachers is must, Government school teachers should be highly competitive, creative and intelligent and independent thinkers. There should be no reservation for teachers post in Government schools. Our country will have a great future if the Government changes its outlook without yielding to pressure from various classes of people

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