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Stockmarket: A fundamental view... - Views on News from Equitymaster
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  • Oct 30, 2007

    Stockmarket: A fundamental view...

    The BSE-Sensex breached another milestone - the 20k mark yesterday led by strong global cues and good quarterly earnings being reported by companies. Infact, the movement of the Indian indices has been the barometer, which has judged the performance of the Indian economy and the happenings in the global markets. This has held true especially in 2007 when a host of both domestic and global factors has led to the increased volatility on the bourses. In this Indian stockmarket.

    A look at the growth of the Indian economy: The Indian economy has been chugging along at an accelerated pace, which can be evinced from the fact that the GDP growth rate has accelerated averaging 6.9% during the seven-year period from FY01 to FY07, while the growth rate in the last four years (FY04 to FY07) averaged 8.6%. In the last two years i.e. FY06 and FY07, the economy has grown at a still faster clip of 9.0% and 9.4% respectively. Both the industrial and the services sectors have been the chief proponents of growth in recent times. The strengthening of economic activity in the recent years has also been supported by persistent increase in gross domestic investment rates from 24.3% of GDP in FY01 to 33.8% in FY06 and domestic saving rate from 23.7% in FY01 to 32.4% during FY06 (Source: RBI).

    As far as inflation is concerned, the wholesale price inflation (WPI) after reaching a peak of 6.7% at the end of January 2007, mainly due to food price shocks, dipped to 3.3% at the end of September 2007. Besides this, the Reserve Bank of India (RBI), in its annual policy statement of April 2007, placed the real GDP growth for FY08 at around 8.5%, assuming no further escalation in international crude prices and barring domestic or external shocks. Thus, the outlook as far as the growth of the Indian economy is concerned is healthy, a fact which is not likely to be impacted by volatile trends in the global stock markets.

    Having said that, all is not hunky dory and there are some daunting challenges that the nation faces. Firstly, the recent upward trend in global prices of major food items has significant implications for the domestic agricultural sector and overall macroeconomic and financial stability. Although the share of agriculture in overall GDP has declined over the years from around 38% in FY81 to less than 20% in FY07, agriculture continues to play an important role in the Indian economy. Thus, volatility in agricultural production has implications not only for overall growth but also for maintaining low and stable inflation.

    Second, as has been mentioned in the past, the absence of modern infrastructure and shortage of skilled manpower are the most critical barriers to growth. While there has been improvement in telecom and railways and ports, progress remains less than adequate in other sectors such as power, coal, water, roads, urban and rural infrastructure. Also, availability of quality manpower continues to be a cause for concern for many of the Indian companies and is critical in specialised sectors such as software and pharma (the former being people-intensive and the latter due to the heightened focus on R&D). Higher attrition levels coupled with lack of skilled manpower across industries and companies could prove to be a dampener to the growth story going forward.

    Impact of global events: The subprime rout in the US and its impact on global financial markets has been a major event that has weighed heavy on financial markets across the world including India. Led by the specter of recession in the US and to lend some semblance of stability to the credit market in the US, the US Fed undertook rate cuts by 50 basis points in September 2007. This has led to the widening of the interest rate differential between India and the US thereby contributing to the surge in the Foreign Institutional Investors (FIIs) inflows into the country. The interest in emerging markets especially India has increased due to the strong growth being reported in the last couple of years. Thus, while the inflation level has dropped in India lending comfort to the RBI, surging liquidity, rising crude prices and any further food price shocks could temper India's economic growth to that extent. Also, while the optimism surrounding the India growth story is not misplaced, the money pouring into Indian equities has contributed to the steep rise in valuations of a majority of index heavyweights.

    To conclude...
    Besides the clarity on the P note front, strong results being reported by India Inc has led to rally on the bourses of late. However, valuations are proving to be a tad expensive and while we continue to reinforce the fact that equity as an asset class is rewarding in the long term, at current levels investors will need to be choosier while picking their stocks. Also, while strong management and earnings visibility definitely need to be considered before putting in money in good quality companies, investors need to be wary of investing in the same at higher prices.



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