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India: Global factors pinching hard! - Views on News from Equitymaster
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  • Jul 8, 2005

    India: Global factors pinching hard!

    After sustaining a smooth sail over 7,200 levels for a week, indices have become jittery over the past couple of trading sessions. It is easy to decipher that sentiment at the record high levels has become cautious and look for reasons beyond company fundamentals to stay invested. Also, as the indices defied the laws of gravity, their resistance to external factors diminished. It is thus pertinent for investors to determine the 'stability' of the external factors before resolving their future course of action. In our attempt to screen some of these factors, we found certain aspects that we would like to put forward to investors as caveats.

    Deceptive surplus: After showing minor surpluses during FY02, FY03 and FY04, India's current account balance slipped into deficit during 2QFY05. It however ended the financial year with a narrow surplus of US$ 2.5 bn down from US$ 12.6 bn in FY04. It is interesting to note that this was while the rest of Asia (excluding Japan) continued to witness higher levels of current account surplus. This divergence reflects the differences in the growth model of India against the rest of Asia. India's consumption spending that is supported by cyclical factors such as low interest rates instead of job creation, is pushing imports to higher levels than exports. In other words, while in the rest of Asia, particularly China, the focus on job creation through higher exports coupled with relatively weak domestic consumption has kept the current accounts in surplus, in India the story is not quite the same.

    Here we have to thank the incessant flow of 'invisibles' (remittances) for saving our face. A large part of the capital flows are being influenced by the global appetite for risk, which in turn is influenced by the US yield curve (US 10 year bond rate less the Fed funds rate). With short rates rising and the yield curve flattening in the US, capital inflows are increasingly slowing. In other words, the foreign inflows that are currently aiding the markets sentiments are 'hot', and will be the first ones to be withdrawn with the slightest hint of slowdown in India Inc.'s growth trajectory.

    Slowing Asian growth machine: According to the IMF's purchasing power parity metrics, Asia accounts for 35% of world GDP. Asia's 'big three' i.e. China, Japan, and India make up 74% of pan-regional output. Post the 1997-98 financial crisis, Asia has grown at an average rate of 5.6% p.a. and accounted for 53% of the average increase in world GDP growth between FY99 to FY04 (Source: World Economic Outlook). With such a contribution, it is easy to comprehend the possible effect of a major downshift in Asian growth on the world economy going forward. It is also estimated that a 2% downshift in Asian growth could knock off 0.7% from the world GDP growth target.

    No points for guessing that the economy that we are most worried about is China. A 'real' slowdown in the growth of the 'dragon economy' will create ripples all over the world, the repercussions of which will be reasonably long lasting. It is also needless to mention that the United States' deficit led growth can do little to fill in the void. Consequently, there is good reason to believe that an Asian slowdown could quickly morph into a global slowdown. The impact of this on the financial markets is unconceivable.

    The oil wildcard: This is another important reason to worry about. Developing countries in Asia are not only the fastest growing regions in the global economy, but are also the most inefficient consumers of oil in the world. For example, China currently requires about 2.3 times as much oil per unit of GDP as does an average developed country. For India, the ratio is 2.9 times the OECD norm. To some extent, this is understandable as Asia is currently in the midst of what could well termed as the most 'energy and materials intensive' phase of its development. That is, capital investments at the current levels are significant for cementing the future growth path. But the region also suffers from a failure to focus on energy conservation.

    Given this, countries like India are extremely vulnerable to a sharp run up in oil prices. Also, because the government camouflages the price hike through its subsidies, the same is not visible on the retail oil prices. However, it will not be long before the government starts passing on the hike to rid the oil companies that are bleeding with the subsidy burden. This will certainly not augur well for the oil dependant sectors that will see a substantial surge in their operating costs.

    Terrorism: Terrorism has been one of most serious concerns that have shadowed global economic growth in the past decade. First it was the September 11 attack in the US, then it was the Iraqi conquest by the Americans, then it was bomb blasts at Madrid, and now the series of blasts in London. All these events are indicative of the danger of terrorism rearing its head time and again. India has had its share of the same as well (attack on the Parliament in 2001 and 2003's bomb blasts in Mumbai). Terrorism not only leads to loss of innocent lives, it also brings economic activities to a grinding halt.

    To conclude...
    As the noted New York Times columnist Thomas Friedman would agree, the world is getting 'flatter' by the day. And India no more remains insulated against the global repercussions. It is then but natural for investors to take cues from global aspects to support their investment decisions. These are certainly not the only factors that you need to look into, but will definitely help you form a broader view. The top down approach is the most advocated method of investing when markets look attractive. But even when they look irrational some of this analysis can guide you better. The legendry investor Warren Buffet once quipped, "The market, like the Lord, helps those who help themselves. But, unlike the Lord, the market does not forgive those who know not what they do".



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