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Stock markets: Beating the retreat - Views on News from Equitymaster
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  • Sep 23, 2000

    Stock markets: Beating the retreat

    The 700-point (or 15%) fall in the BSE Sensex has left many aghast. The fall, which was spread over just eight trading sessions, surprised many by its suddenness. Finally, after persistently ignoring, the markets have given due weightage to the deteriorating economic fundamentals. The results to many, however, have not been as surprising.

    Letís take a look at the factors, which make the recent decline in indices look more fundamentally driven. After recording heady growth, industrial growth has slowed down to just over 4%. Infact industrial growth peaked at 12.6% in February this year. The key factor contributing to this was the drought in several parts of the country. If one were to go a little deeper into the factors driving demand the not-so-comfortable situation would become clear. In FY00, industrial demand was spurred by consumption expenditure. Investment expenditure, which is essential for a sustainable economic recovery, failed to pick up as business confidence continued to remain muted. Even as demand picked up, the corporate sector was faced with the prospects of escalation in costs (higher oil prices) and rising interest rates (volatility in the forex markets and rising inflation). These factors further depressed investment activity. Another factor that is now contributing to a slowdown in industrial growth is slower growth in exports. After recording growth in excess of 30% in both April and May, growth slowed down to 17% in July.

    On the external front too the scenario does not look encouraging. FII inflows have slowed down even as foreign direct investment growth continues to be below expectations. The trade deficit has been rising in recent months largely due to a sharp rise in oil prices. These factors have contributed to volatility in forex markets. This volatility was primarily responsible for the RBIís move to raise interest rates in July. (A persistent depreciation in the Rupee could once again prompt the RBI to raise rates.)

    The most important factor however has been the rise in oil prices. Oil prices will hit the economy in several ways. First consumption demand will be hurt as individuals spend more on fuel. This in turn will further dampen investment demand (why build more capacity when there is no demand). Secondly, higher oil prices will inflate costs of production. Companies can either choose to absorb this rise (lower margins) or pass them on at the risk of adversely affecting demand. Thirdly, from a macro point of view, the government will witness an escalation in its subsidy bill (albeit off budget). Attempts to pass on relief (like reducing customs duties) will then reflect in the budget. This could mark a turnaround in the recent improvement in central government finances. And finally, as mentioned before, rising oil prices will contribute to a larger trade deficit.

    All these factors make it clear that fundamentally the scenario had changed quite dramatically since the start of the year. The stock markets were however still to react. Now, however, the gravity of the situation seems to have dawned in earnest.

    Does that mean all is gloom and it is time to head for the exit? Well, that too would not be the right approach. Investors need to rebalance their portfolios to include anti inflationary investments like gold. Also there is a need to keep an exposure to stock markets (at any point in time the markets do offer an opportunity). Remember, after all the Indian economy will continue to be one of the fastest growing nations in the coming years.

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