What is it that we are talking about? Indian economy, the stock markets or crude oil prices? Both - the Indian stock markets and crude oil prices have now got accustomed to touching new highs everyday. So much so, that we have stopped rejoicing at BSE-Sensex touching 7,900 levels and worrying about oil touching US$ 67 per barrel! Also, natural calamities and geo-political threats have failed to ruffle the feathers of the Indian investor. While we support the former (Sensex rally) on the back of adequate rainfall and revised GDP target (the latest is 6.8% for FY06), the latter (crude prices) has historically been the government's headache.
Although it is common knowledge that Foreign Institutional Investors (FIIs) have been the major drivers of the rally (having pumped in US$ 7.4 bn in 2005 to date), what is incomprehensible is the fact that domestic mutual funds (MFs) are also showing interest at the current high valuation levels. The debatable factor, therefore, is whether India is still 'shining'. Is the economy progressing at a comforting pace or beneath that seemingly tranquil surface, the imbalances and tensions are only getting worse?
Arguments in favour
Sufficient rainfall...: ...or should we say more than necessary? While the better part of the country has been blessed with adequate rainfall this monsoon, the rain Gods have been more than generous on certain regions (like Maharashtra, Gujarat and Karnataka). In a primarily rain-fed agri economy like our's, rainfall signals better prosperity of the rural economy (70% of the Indian economy) and filtering in of the same into the industrial (higher production of consumer durables) and service sectors (banking and insurance).
Free trade policies: The recent Comprehensive Economic Partnership Agreement (CEPA), a bilateral agreement signed between India and Singapore, is a combination of Free Trade Agreement (FTA), a bilateral agreement on investment promotion and protection, an improved double taxation avoidance agreement and a program of cooperation in tourism and other fields. The same augurs well for the Indian economy given that Singapore is India's largest trade partner in the ASEAN. This is because, while it is difficult for these singular developing nations to manifest their economic muscle in bilateral economic negotiations (on platforms like the WTO), a combined effort will lend them better momentum.
Arguments not in favour
Interest rates looking up: With the government's Rs 80 bn borrowing programme on the anvil, the excess liquidity may soon be sucked out. The fresh G-Sec offerings are also expected to be at a premium coupon rate compared to the current benchmark 10-year G-Sec yields. The same may trigger an upside to interest rates thus paving the way for inflationary pressures.
Oil price hike on the anvil: The 40% rise in crude oil prices over the past 6 months has caused the doomsayers at US$ 50 or even US$ 60 (per barrel of crude oil) run for cover. Yet, thanks to subsidies, Indian consumers have been helped to maintain their apparent resilience to this full-blown energy price shock. The standard rule of thumb suggests that every US$ 10 increase in oil prices should knock off about 0.4% from the GDP growth rate during the following four quarters. Couple this with the fact that most of our domestic energy giants are in the red. The ministry's proposal for price hike also seems to be finding few takers. However, it is undeniable that there is limit to which the government can dig into its pockets.
Left is not always right: Most of the government's proposals, be it disinvestments, higher FDI limits or oil price hike, are invariably met with 'stiff opposition from the Left'. The worrying factor is that if every time reforms are put on the backburner due to the Left, nothing may finally turn out to be right!
Relying on the 'strength' of the US economy: Like most other economies, the resilience of the Indian economy to macro-events is also aided by the strength in the US economy. In the US, personal consumption growth continues to track a 5.5% gain in 3QCY05. The Fed also seems to be content with the fact that the contained inflation shows signs of economic 'revival'. Nevertheless, the noteworthy fact is that the stellar accomplishment has been at the cost of personal savings rate hitting rock bottom (0% levels), accelerating debt burden and property bubble. Courtesy surging oil prices, inflationary concerns also are not to be sidelined. While the US' penchant for spending may make sense in normal periods, it is seemingly reckless in the face of an energy shock.
To put things into perspective, in the two oil shocks of the 1970s, the personal savings rate in the country averaged about 9.5%, whereas in the oil shock prior to the Gulf War of 1991, it was around 7%. This means that in each of those earlier instances, US consumers had a cushion of saving they could draw upon in order to maintain existing lifestyles. Today's 'zero' savings rate underscores the total absence of any such cushion. The only support available now is the savings embedded in their over-valued homes.
Given this, if the US bubbles were to 'burst', India's illusions about capitalising on the 'US potential' for IT outsourcing, pharma and auto sectors, will also not see the light of the day.
It requires no genius to conclude that the disturbing arguments clearly outweigh the comforting ones. However, the 'greed factor' in the market seems to be too tempting to keep the retail investors out of the insane rally. We therefore chose to put forth the above facts to help investors take an 'informed' decision.