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Stockmarkets: Staging a comeback?

Nov 9, 2005

After the gravity-defying sprint witnessed in the benchmark indices for the better part of the year, the strong sell off over in the month of October 2005, seemed to have left investors jittery. However, one wonders whether the 'even stronger' pullback in the past few trading sessions (BSE-Sensex has gained about 9% in about 5 trading sessions) is an early sign of a 'comeback'? While we have time and again hazarded a repetitive tone to reiterate that such market tantrums are for long-term investors to ignore, we also believe that there are several noteworthy features of India's recent macroeconomic performance that can help the Indian markets develop some resilience to the 'FII activity' (whether buying or selling) in the longer term.

  • The investment climate (symbolised by credit and debt ratings) has improved and industrial and service sector activity has picked up. This has also reflected in the Reserve Bank of India (RBI)'s increment of GDP growth target to 7.5% for FY06.

  • Buoyant exports have emerged as the demand driver for a broad spectrum of industries. The impact of any slowdown on India may be assessed with reference to two factors. First, India's economy is largely domestic-demand driven. While India's exports constituted 11.5% of GDP, its share in the world trade is only 0.8%. Second, India's exports basket is fairly diversified.

  • There has been a modest attempt at and a commitment to achieve fiscal consolidation.

  • The trend inflation has declined over the years and inflation expectations stabilised (5% to 5.5% for FY06).

  • India has been successful in managing liquidity against the backdrop of continuing capital flows.

  • India has emerged as a preferred destination for foreign investors and received about a quarter of the global portfolio flows to the emerging market economies in 2004.

  • India's foreign exchange reserves are in excess of the total outstanding external debt of the country.

  • The performance of the corporate sector (barring some aberrations in certain sectors in the previous quarter) has improved and the demand for goods has encouraged capacity expansions.

  • India's financial markets have deepened, widened and become vibrant over the years with a robust institutional framework and market infrastructure in place.

  • The profitability and soundness indicators of the banking sector (net interest margin and Net NPA) have improved.

  • India has been adopting international benchmarks for financial standards and best practices (US GAAP and Basel norms to name a few) with suitable adaptations for Indian conditions.

All said, global financial imbalances and high and volatile oil prices may accentuate India's inability to adjust its investment standing. A spurt in interest rates could magnify and propagate the problems associated with increasing debt levels (at the household, corporate and government levels) and rates of sub-investment grade borrowers could increase. Increasing pressure on currency (as has been seen of late) could also weigh heavy on the already burgeoning deficit position. Here, we must acknowledge, that while India by itself hardly contributes to global financial imbalances, any large and rapid adjustments in major currencies and related interest rates or current accounts of trading partners could indirectly impact the economy.

We thus believe that while markets will continue to gamble on short term driven sentiments, long-term investors, instead of trying to draw cues from the same, should stick to their risk-return based strategy. The same will not only relieve them of unnecessary despair but also hedge them against the market's wild dispositions.

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