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Markets: So far, eventful indeed! - Views on News from Equitymaster
 
 
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  • Oct 17, 2007

    Markets: So far, eventful indeed!

    Markets so far have been subject to a number of events that have had a telling impact (both positive and negative). The latest in chronology is the Securities and Exchange Board of India's (SEBI) proposed restriction on the issue of fresh participatory notes (P Notes) by Foreign Institutional Investors (FIIs). Both domestic and international events have influenced the movement of the stockmarket. In this article, we shall recapitulate the major events this year, which have impacted the Indian stockmarket to a considerable degree.

    Global events...
    Subprime crisis: This was perhaps the biggest event that marred both the international and the domestic stockmarkets. Most of the world's well-known financial giants like Bear Sterns, Lehman Brothers and Merrill Lynch created complex derivatives based on sub prime loans, which were marked to market and sold. The crisis arose when defaults on these sub prime loans surfaced having a dampening effect on other forms of credit as well. While big hedge funds such as Bear Stearns amongst others had to report bankruptcy, global banks were not spared either and the largest of the lot i.e. Citigroup reported a massive 60% drop in its third quarter earnings for the year. UBS was also at the receiving end and ended up posting losses. Since complex financial instruments were created around these sub prime loans, valuing the same proved to be a difficult task, as a result of which the extent of the crisis could not be gauged.

    While the India does not have a significant exposure to the mortgage market and thus is relatively insulated in that sense from the developed markets, the subprime rout nevertheless had a huge impact on the Indian stockmarket. This can be largely attributed to one word - FIIs. The sub-prime crisis saw the FIIs book profits on the Indian stock markets to pare their losses in the other global markets, thus highlighting the vulnerability of India to external shocks.

    Fed rate cut: A fallout of the subprime crisis, the Fed chief Ben Bernanke announced a 50 basis points cut in the Fed rate. The rate cut, being more than what the markets expected, spearheaded a rally in the US, European and Asian markets and India was part of the action too. For India, what the fed rate cut meant was that with the RBI not lowering the interest rates in India, the interest rate differential between India and the US increased. This sparked a renewed interest by the FIIs into India and led them to pump in money to the tune of US$ 7.2 bn since the rate cut was announced on September 18. The fact that the Indian economy has been chugging along at a robust pace has also been the icing on the cake.

    Domestic events...
    CRR hike: In a move to contain inflation, the RBI undertook raising the cash reserve ratio (CRR) twice during the year. The first was in Feb 2007 wherein the RBI increased the CRR by 50 basis points to 6%. The next was in April 2007 when the Reserve Bank of India (RBI) raised the CRR by another 50 basis points to 6.5%, which was made effective in two tranches. Besides this, it also raised the 'repo' rate from 7.5% to 7.75%. The move behind the same was to curb the excess liquidity in the banking system to check inflation. Now with liquidity once again flooding the Indian markets, the possibility of the RBI once again resorting to a hike in the CRR cannot be ruled out.

    Sharp rupee appreciation: The surge in FII inflows and the not so active intervening by the RBI in the forex market (to curb liquidity and thereby inflation) has had a scathing impact on the exchange rate causing the rupee to appreciate by around 7% against the dollar this year. No surprises for guessing that the major sectors at the receiving end have been the software, textile and pharma sectors. FII inflows showed no signs of abating this year and the recent move by the US Fed to cut interest rates have further fuelled inflows into the country largely due to the robust growth in the Indian economy and the widening differential between the Indian and the US interest rates. The fact that the dollar has weakened against the major global currencies has also contributed to the appreciation of the rupee.

    While the RBI has come out with guidelines encouraging investments abroad, this move may not be that effective given the strong pace in the growth of the Indian economy and the attractive interest rate scenario.

    To sum up...
    While there is general euphoria in the markets with the Sensex reaching 19,000, what needs to be noted is that valuations at the current levels appear stretched. Investors need to ensure that they do not get carried away by the hype and hoopla surrounding the various milestones reached by the BSE-Sensex. What's more, these times of all times, will test the mettle of the investors who will have to exercise considerable discipline in researching and investing in stocks, which have good managements, earnings visibility and are available at reasonable prices.

     

     

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