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Await further clarity - Views on News from Equitymaster
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  • May 20, 2004

    Await further clarity

    Finally India is set to see its 14th Prime Minister today, exactly seven days after the poll counting began. Though a span of seven days might look very small but in the interim, Indian stock markets made history by losing more than 10% on a single day (17th May 2004). If we were to watch it closely, it was mainly due to political uncertainty prevailing in the country during that period. The Foreign Institutional Investors (FIIs) trends are also discouraging for the markets as in the month of May till date, there has been net out flow of US $ 661 m from equity markets.

    But with things becoming relatively stable on the political front, markets have recouped some of the losses in last two trading sessions and have again reached 5000 levels. Reserve Bank of India's monetary policy, which has maintained the status quo on interest rates, has also helped the markets by keeping interest rates on the lower side, ensuring cheap credit availability for companies to further their expansion plans. The RBI's projection of GDP growth of 6.5% to 7% is an indication that India in going to be one of the fastest growing economies in the world.

    So is this enough for investors to take fresh exposure in the markets? We believe not quite as yet. Investors will have to keep certain things in mind before making any kind of decision like:

    Would the newly formed government be able to provide political stability to the country? What will be the stand of government towards the reform process? Will they be able to increase the pace of reform implementation or will it slow down because of different political agendas of the coalition partners. Though the early signs toward reforms are not encouraging, it should not be forgotten that the victorious party is the one that is considered to be the architect of reforms in the country.

    With Crude prices at 13 year high and likely to strengthen further with high demand from US and other developing nations, the higher import bill of crude is likely to have a negative impact on the fiscal state of the country (higher deficit). Thus it can lead to interest rates rise going forward as government raising more money from markets.

    If government decides to pass on the effect of higher crude to the consumers, then their will be an upswing in the inflation in the country from the current expected 5% levels. In order to control higher inflation, government will have to strengthen the interest rates in order to keep under certain levels. Rise in interest rate will slower down the demand of housing, consumer durables and others to some extent. Just to give an example, a 1% change in interest rate (from 7% to 8%) on a Rs 5 lakh housing loan for 20 years will increase the EMI payment by around 8%. Thus looking at the percentage rise in the EMI outflow every month, the consumers may defer their demand to an extent.

    Higher interest rates are also capable of diverting equity market funds to debt markets, as investors may prefer risk free government bonds as compared to high-risk equities. Further any rise in the US interest rates may see a shift of FII money from Indian equity markets to US debt funds.

    We would like to conclude by saying that it is too early to form any kind of opinion about the government before it takes the charge. Investors should look forward to the Common Minimum Program, which will give a broader picture of government's direction of work. Once the confidence in the new government policy start coming, markets may witness fresh investments from the global investors. But it will definitely take some time. So short-term trends should not form any kind of base to form expectations from markets for the long-term investors.



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