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Concerns at 19k

Oct 16, 2007

The Stcok markets are hitting new highs everyday. Strong GDP growth, stronger rupee, and lower inflation numbers are some of the positive factors that have supported this momentum. But the question is, will this euphoria last forever? There are the negatives that could hamper the upward journey. Political Instability: This is one of the prime concerns. Politics is the art of the impossible, and even more so, figuring the impact of politics on the stock market. Political instability creates doubts in the minds of the foreign investors and may lead to the fall in the markets. Though the recent concerns over mid-term polls has not led to the stock market correction, cautiousness on this front is needed. The present political imbroglio over Indo-US civil nuclear cooperation deal presents a big event risk. History suggests that in this kind of situation Indian markets have reacted sharply.

Huge inflow- RBI stand: Capital inflows have increased dramatically over the past few weeks. During the fortnight ended September 28, foreign exchange (FX) reserves increased by US$ 15.6 bn. 12-month trailing capital inflows as of September 2007 increased to an all-time high of US$ 75 to 80 bn as compared with US$ 27 bn during the 12 months ended September 2006. The key driver of the recent rise in capital inflows has been foreign loans and portfolio equity inflows. This has led to the intervening of the Reserve Bank of India (RBI) to prevent sharp appreciation in the rupee and in the money market to ensure that short-term interest rates do not decline.

US economy: The US economy is facing the pressure of the credit and mortgage sectors. Though the Fed has reduced the interest rates, negative impact on the long term on credit crisis still exist. The temporary cure would further aggravate it, leading to inflationary pressures. With US being a major source of exports from India, this may create problems for our economy. Also, the risk of a reversal in capital inflows due to risk aversion to recent problems in the credit markets in the US and Europe may cause a fall.

Crude prices: The crude prices have gone up by 34% YoY. India imports around 75% of its crude requirements. With higher crude prices, the trade balance would get affected. Also, it would cause inflationary pressure across all products and services, which could slacken the demand growth pace.

Input pressure: Though the data released every Friday on inflation shows a decline in inflation on YoY basis, the real picture faced in routine life is harsh. Not only crude but also the other raw materials have become expensive. As per ASSOCHAM's recent report, prices of major commodities have shown maximum price fluctuations to the extent of 23% to 25% over the last one year. Not only the consumers but also the companies are facing the brunt of higher input prices, which would affect their operating margins. While, headline inflation is at 4%, core inflation is at 4.8%. Although both core and headline inflation is within the RBI's comfort zone of 5%, the recent rise in oil and foodstuff prices has raised concerns.

Trade deficit: India's April-August 2007 trade deficit climbed to US$ 32.5 bn, 63.3% higher than that of US$ 19.9 bn last year led by stronger rupee and higher crude prices. The widening trade deficit would also pressurise the current account deficit. Further, as per the RBI, the shortfall in the current account was US$ 4.7 bn in the three months ended June 30 2007, as compared with a surplus of US$ 2.6 bn in the previous quarter. The rising rupee would hurt export-oriented industries and their competitiveness and any slowdown in these industries may affect overall growth outlook.

Higher valuations: After the recent fall in the global markets due to the sub-prime crisis, India has been one of the few emerging markets to see strong rise in the sensex. On a trailing 12 month basis, while Shangai A share is 54.66, Sensex is 25.47 as compared to Russia's RTS index value of 13.49 and Thailand's 17.99. The valuations are on the higher side ignoring factors like relatively lower IIP growth, high crude oil prices and the continued political clash on Indo-US nuclear treaty and stretched valuations.

To conclude...
While we continue to remain bullish on long-term growth prospects of the economy, we believe that valuations become little stretched at this point and markets are running ahead of fundamentals. With valuations taking a backseat in this mad rush of capital inflow, we advise investors to concentrate on the fundamental aspect and not get carried away by the one-way movements in the indices.

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