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Should you ignore global factors? - Views on News from Equitymaster
 
 
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  • May 10, 2005

    Should you ignore global factors?

    Recently, we had conducted a poll on our website, asking investors whether they considered global factors while investing in Indian equities. While the majority (65%) has answered in the affirmative, 31% are on the other side of the fence, i.e., they do not consider global factors while making their investment decisions. Considering the kind of volatility seen in the Indian markets over the past few months on account of concerns on crude prices, US economy and Foreign Institutional Investors (FIIs) inflows, those who still ignore global factors 'must' read this write-up.
    If one were to take a look at the adjacent chart, it clearly indicates the high levels of correlation that has existed among the Indian, US and South Korean markets. While the relation with the US markets has somewhat declined in the past one year, it has been much due to heightened concerns with regard to the rise in interest rates in the US, which has the potential to slow down consumer spending, the torch-bearer for the growth of the US economy in the past couple of years. On the other hand, the relative faster rise in the Indian and South Korean markets is fallout of a spike in FII inflows to emerging nations during this period. It must be noted that the real interest rate in the US has been lying at its all time low for some time now and this has led to FII money flowing to emerging equity markets that have promised higher returns. India is a case in example, where equities have attracted around US$ 18 bn in the last 2.5 years. However, concerns in the US regarding the faster rise in interest rates has spilled into the emerging nations' equities as this might lead to a flight of capital to he much safer US treasury bills and bonds.

    The world's moving in a loop...
    In the past few years, the developing regions of East and South Asia (excluding India) have been so 'engrossed' in being the manufacturing hub for the developed world (read again, the US) with all their low cost offerings, that they have almost failed to give heed to a more fundamental factor of growth - the internal demand. As a result, countries like South Korea are currently facing the threat of deflation, as the demand for industrial goods has failed to pick up in the economy. On the other hand, the highly indebted and saving short US consumer is facing the double threat of rising inflation and consequent rise in borrowing costs.

    The US has piled up a huge current account deficit (to the tune of around 6% of their GDP). Now, despite such a strong consuming demand for credit, interest rates in the US have been lying low and the real interest rates (adjusted for inflation) have remained almost negative. There are two key reasons for the continued strong consumption demand from US consumers. One, they are borrowing and spending money at negative interest rates (part of this is being invested in emerging market equities). Two, to counter risks of currency appreciation due to high dollar inflows, the forex reserves that these emerging nations have built up are re-invested in US debt thus adding to the liquidity in the US money markets, which consequently results in interest rates remaining low. This has turned out to be vicious circle and has caused the current imbalance in global money and currency markets.

    ...and this loop has an end!
    One major way to correct (or reduce) the impact of this imbalance is the gradual depreciation of the US dollar that would make US exports competitive, thus helping in reducing its current account deficit. However, there is a negative side to this as well. The depreciation of the US dollar will lead to heightened inflationary pressure in the country, a hint of which was given by the Fed recently. The Fed has indicated that interest rates might increase faster in the future.

    Another remedy for correcting this imbalance in global savings rate, i.e., extremely low US savings rate and high in emerging nations and partly in Europe, is to increase internal demand and reduce dependence on the US consumers to carry on the global growth engine. While India has a relatively lesser dependence on the export-led growth (around 12% of GDP), it is not to say that the internal demand in India is yet to pick up pace.

    If the global imbalances, as mentioned above, are not corrected shortly, the world (non-US) might have to deal with more volatile currency markets and consequently other financial markets like equities and debt. Other global concerns like rising crude prices and terrorism also required to be looked into. The Indian investor in equities 'has' to give heed to these global factors before making his investment decision. He, in fact, has no other option!

     

     

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