Indian markets - two to tango?

GUEST COLUMN: TORCH-LIGHT

While high FII inflows drive the Indian equity market, strong consumer demand boosts the commodity market. But going by global experience, both may not be able to hold up at the same time.

While the global financial community is well aware of the ongoing boom Indian equity markets are witnessing, only a small section is aware of an unusual phenomenon alongside.

Strong consumer demand and higher corporate earnings have led the domestic commodity and equity markets to an uptrend together. Commodity trading in the country, which was banned in the 1960s, resumed in 2003 through the Multi-Commodity Exchange (MCX) and the National Commodity and Derivatives Exchange (NCDEX).

Though the commodity market - which includes crude and edible oils, foodgrains, metals and precious metals such as gold and silver - and the equity market are controlled by different factors, they have been on an uptrend in the country for two years now, which is contrary to global market trends.

Strong inflows from foreign funds and improved earnings have resulted in over an 80 per cent growth in the bell-weather BSE Sensex over the past 15 months. Foreign funds have already pumped in about $7.3 billion till date in the first four months of the current fiscal (April-July), which approximates the previous fiscal year's total investment of $8.5 billion.

It is accepted that FII inflows are primarily due to the much touted 'India growth story' which pegs the country as an alternative equity investment destination to China. Resultantly, there have been huge fund inflows from countries such as Japan, Korea and Taiwan into the Indian equity market.

Interestingly, trading volumes in the Indian commodity market have also seen a steady rise - to Rs 5,71,000 crore in FY05 from Rs 1,29,000 crore in FY04. In the current fiscal year, trading volumes in the commodity market have already crossed Rs 3,50,000 crore in the first four months of trading.

Excessive liquidity and benign interest rates have been vital for such growth in the two markets in India. Unlike in the past, dedicated and hedge funds are making huge investments in the commodity market.

Furthermore, a boom in construction and infrastructure activity fuelled demand for steel and other base metals in rapidly growing economies like India and China, resulting in a surge in interest in the Indian commodity market.

It is noteworthy that the commodity and equity markets have been moving in tandem, bucking the global market trend. The growth of a sizeable section of the middle class with increasing disposable incomes has led to a hike in consumer spend in India. This fact is reflected by the demand for consumer goods in India which have recorded a 23.7 per cent growth in production in June 2005, over the same period a year ago.

Apart from fundamentals, the introduction of electronic trading in commodities has also fuelled the uptrend and this has coincided with the rise in equity markets. With a GDP growth forecast of over 7 per cent , and this year's monsoons likely to fuel robust agricultural output, the market expects the current uptrend in both markets to continue simultaneously.

Although there could be a correction in equity markets due to a slowdown in flows from foreign funds and high crude prices, the trend for commodities still appears healthy. Since the commodity cycle is normally for 10-15 years, the consensus is that strong demand for commodities will comfortably continue for another 10 years.

The strong local demand for metals is expected to grow the commodities market and industry by about 7 to 8 per cent, while high purchasing power will boost consumer spending. On the other hand, with crude price nearing record levels, there are fears that the equity market could crack in the near term.

The speed at which the Indian commodities market has grown can be put in better perspective by turning the 'torch-light' on the following statistics:

Equity trading volume on the BSE stands at Rs 3,96,574 crore between January and August 2005, compared to Rs 5,33,478 crore during 2004.

Commodity trading volume is up to over Rs 3,50,000 crore between January and May 2005 from Rs 1,29,000 crore in 2004.

While high FII inflows drive the Indian equity market, strong consumer demand boosts the commodity market. One of the two will have to crack up to adhere to the global phenomenon of having only one of the two markets faring well at a given point in time.

It would please domestic investors if the current phenomenon of both the markets faring well simultaneously continues. But that seems unlikely. If one of the two markets has to crack earlier, it is more likely to be equity. Till that happens, enjoy the Indian tango.

(The author heads Lotus Knowlwealth, Mumbai, and can be contacted at ceolotus@hotmail.com . )