“The stock markets are filled with individuals who know the price of everything but the value of nothing”- Philip Fisher.
Since currency markets are very nimble-footed and a precursor to stock market behaviour, it is evident that rupee weakness leads to a vicious cycle of higher imported inflation, higher current account deficit, higher government borrowing, lower credit growth and higher fiscal deficit in the wake of falling tax revenues. This in turn leads to higher inflation, rising interest rates, lower corporate profits, lower earnings yield and rising bond yields, all of which finally manifest themselves in falling markets. Precisely what we have witnessed in the last one year.
But herein lies the catch. I believe the rupee will stabilise at 53 to a dollar, over the next 9-12 months, driven by a lower current account deficit, in turn driven by falling gold imports. Gold normally moves in a 10-year cycle and the gold rally that started in 2002, after hitting a peak last September of $1,922 an ounce, is now nearing its end with gold prices at just about $1,600 an ounce.
What can further aid potential rupee appreciation and fuel a stock market rally is the Reserve Bank of India’s (RBI) willingness to float a bond issue on the lines of the Resurgent India Bonds or the India Millennium Deposits, which should easily rope in $15-20 billion. In fact, even after including hedging and transaction costs, assuming RBI borrows at 200 basis points (bps) above Libor, it would still be able to rope in dollars at a price lower than the going rate of 8.44 per cent on a 10-year government bond.
Industrial growth in 2008-09 came in at a mere 2.8 per cent, following the Lehman crisis. However, it quickly rebounded to 5.3 per cent in FY10 and 8.3 per cent in the following year. We expect industrial growth to rebound to roughly five per cent in FY13, helped partly by the low base effect and largely by stimulus packages that the government should ‘pump prime’ the economy with.
With elections in Gujarat and Karnataka in the next one year and general elections in 2014, it would be suicidal for the incumbent government not to “unleash higher growth”. Why would the ruling coalition want to commit suicide when it has a good chance of winning, helped by a deeply fractured opposition?
Also, while in the long term a liquidity surge is anaemic for economies globally, in the interim it boosts asset inflation, stock markets included. Poor M1 growth of between two to three per cent in China and Europe suggests monetary easing and more long-term financing operations coming our way. A 50 bps reduction in reserve requirements in China for instance, unleashes 400 billion yuan ($63 billion) into the Chinese banking system, which through the ‘money multiplier spillover effect’ should push up risky assets like emerging market equities, Indian equities in particular.
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Limited liquidity normally chases safe havens. Excess liquidity brings back animal spirits and chases growth and even at a nominal gross domestic product (GDP) growth of 14 per cent, India is far ahead of the western world, which is struggling with a nominal GDP growth of barely three per cent. Also, nominal GDP growth of 14 per cent means the government can grow its spending 14 per cent year-on-year and still have a constant debt/GDP.
The author is managing director & chief executive officer, Violet Arc Securities Pvt Ltd