It is tempting and perhaps natural to attribute the post-Budget sell-off in the stock market entirely to the disappointment over the Budget. It is equally tempting to attribute the subsequent rally to the attempts to soothe market sentiment by the finance ministry. However, that would be incorrect.
The Budget came on a day that global markets for all risky asset classes (stocks, commodities and the like) sold off following the release of weak unemployment data. Oil prices (that have now become a gauge of risk rather than the balance of demand and supply for oil) dropped by as much as 6 per cent between July 6 and July 8. The rally that followed reflected to a large extent the return of risk appetite following unexpectedly robust results from investment banking giant Goldman Sachs. Other results from American banks and companies were also somewhat better than expected. This momentum has sustained.
The implication is that it might be misleading to try and predict the behaviour of Indian markets on local news flow alone. There is still a large degree of uncertainty over the future course of the global economy and that is keeping investors on edge. A rise in investor anxiety translates into a bid for the dollar and a tendency to sell risky assets including India stocks. An increase in confidence translates into exactly the opposite effect — the dollar loses and risky assets gain. This cross-flow of news and data is likely to keep the Indian markets volatile in the next few months. Local events and policies will drive temporary variations — the broad trend will be determined by what is happening in London, New York and Tokyo.
I am not convinced that globally, risk appetite is making a sustained come-back. In fact, the sharp sell-off assessment in commodities and stocks in the first week of July suggests that the euphoria over the so-called ‘green shoots’ of recovery is abating. Markets are waking up to the possibility of deflation rather than inflation emerging as the key macro-theme going forward. Investors are again fretting over the fact that the ‘fundamentals’ — credit growth, employment — of both the US and European economies are weak and getting better. A weak labour market hurts consumer demand. Lost jobs also increase the risk of delinquency by retail borrowers. Investors are rediscovering these somewhat obvious links that they temporarily seemed to have forgotten.
The drag on the global economy at this stage appears to come more from Europe than the US. Credit growth in the monetary union seems to be falling at a sharper pace than before. There are renewed concerns about the fate of the loans made by European banks to the central and eastern European economies. Questions are being asked about the survival of the union itself given the divergence in the economic situation across member countries.
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What does it mean for India? For one, the possibility of a sustained bull run in the equity markets is somewhat remote in this highly uncertain global macro environment. It is too early to even think of the risk of bubbles building up in the stock market and explore policies to prevent this. Swings in risk appetite in the presence of high liquidity will lead to periodic ‘overshooting’ and ‘undershooting’ in stock prices. But what goes up will come down rather quickly. The fear of sustained overvaluation in Indian asset prices is a little premature. This holds for the rupee as well and a phase of appreciation is likely to be followed by reversal.
Second, if risk is indeed alive and well in the global markets, the prospect of a sustained rise in commodity prices is also somewhat weak. I am not suggesting that oil prices will not move back over $70 a barrel or higher but they are unlikely to stay there long or continue to climb. Domestic monetary policy will have to factor this in. The fear that excess domestic liquidity could help embed inflation impulses from the global commodity markets is exaggerated simply because the spurts in commodity are likely to be ephemeral. I hope that the RBI does not become ‘over-vigilant’ and switch the music off even before the party has started.
In the longer term, it is possible for some Asian markets including India to decouple from the rest of the world. This would ensure a more stable supply of external capital. This might be desirable from the policy perspective given the imperatives of funding government borrowing and setting aside enough cash for private investors. However, this isn’t likely to come easy.
I think that there is a limit to which we can flog the structural ‘India story’ and associated clichés like the demographic dividend. There is also a limit to which foreign investors will look up to us with reverent awe at the fact that we have grown at close to 7 per cent. I think there is genuine concern among foreign investors that domestic policy isn’t as aggressive and reform-oriented as it needs to be in the wake of a crisis. The Budget seemed to confirm this fear. There is serious competition for a share of the foreign fund pie from China that always seems to get its act together much faster than us. There are other Asian economies like Indonesia on investors’ radar screens that offer the twin advantages of a large domestic market and ‘kick ass’ (at least relative to India) under President Yudhoyono.
The bottom-line should be obvious. We are still not out of the woods yet as far as global risk appetite goes. If we want external capital to reward us for some of our intrinsic, structural attributes, we have to make sure that we have the right policies in place and, equally, communicate this to the rest of the world succinctly and transparently.
The author is chief economist, HDFC Bank. The views here are personal