Analysts believe while domestic demand is robust, any large stimulus like a QE3 will hurt India’s growth.
Ever since the S&P downgraded the AAA rating of the US, the markets have seen some wild swings. While the initial panic may have settled, equity is clearly not the most favoured asset class. According to Royal Bank of Scotland’s estimates, India’s households’ equities exposure, excluding promoter stakes, stands at $257 billion. This is down $33 billion or 12 per cent from end-2010. RBS has derived this estimate by summing direct retail ownership of Indian equities and domestic institutional ownership of Indian equities (assuming that the bulk of domestic institutional equity holdings reflect indirect household ownership).
Over last year, equities have given negative returns, primarily because a majority of foreign investors have been negative on India and rising raw material prices have hurt growth. While some of these have re-rated India to market weight, the big question remains whether FIIs will sell India as in 2008. According to Deutsche Bank’s Global Markets Research team, this is unlikely. “However, this could be triggered in the event of a hard landing of the Indian economy and corollary risks to the banking system, both of which we do not endorse currently.”
For faith in Indian markets to return decisively, the fear of policy paralysis would need to abate convincingly. While much noise has been made about the Reserve Bank of India (RBI) putting an end to rate rises due to a slowdown in the developed parts of the world and the impact of falling commodity prices on India, analysts believe that for a decisive close to this, there needs to be a “meaningful” slowdown in global commodity prices and a conscious attempt by the government to address fiscal consolidation.
Undoubtedly, India looks attractive if one looks at decelerating economic conditions in other parts of the world, but this so-called sweet spot that Indian equities are in will last only till another round of quantitative easing (QE) comes from the US. Its central bank has signalled a focus on growth and employment generation, by committing to low interest rates and a preparedness to bring in QE3. While a small quantitative easing may be good for global liquidity and growth, anything more will push up prices of commodities and, therefore, impact India’s growth further. A worldwide bias for growth may impact RBI’s decision. However, strong IIP numbers implies the central bank may opt for another 25 bps rate rise in September.
After calibrated policy moves in 2008, the world’s central banks are going their separate ways. While the developed economies are choosing to hang on to loose monetary policies for now, emerging market regulators like RBI are going ahead with rate tightening. Here lies the dichotomy, even as the world is struggling to drive growth, India’s central bank is seeking to curtail the demand. Economists believe that the pro-growth bias of the developed world will impact central bankers in emerging markets, too.
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So, will the central bank bite the bullet and pause? Not in September, at least. One reason could well be the strong June industrial production (IP) growth, which came in at 8.8 per cent, higher than expectations consensus estimates of 5.5 per cent.
According to Barclays Capital Research India, this upside surprise in IP will give further strength to the RBI's hawkish stance and its bid to contain inflationary pressures.
The factory output growth figures suggest while a pick-up in investments pushed up overall growth, this trend may not continue in the third quarter of the calendar year, as suggested by the moderation in manufacturing PMI from a peak of 58 in April to 53.6 in July.
More export demand, a strong demand driver of industrial production, is also showing signs of a sharp slowdown, says Nomura. The combined effect of weak consumption and dwindling exports will also likely start to affect upstream capital investment, which should cause an overall slowdown. Even as signs of a growth slowdown are blinking red, RBI is likely to overlook such signs until inflation starts to moderate meaningfully.
However, recent global developments mean that market expectations of further QE measures from the US Federal Reserve remain on the agenda and global interest rates are likely to remain lower for longer. This could push asset prices up, adding to existing domestic inflationary pressures. But the recent volatility in global markets did take a take a toll on Indian markets.
Prices have adjusted significantly, sentiment has suffered, and questions have emerged about what measures can bring stability. If the recent bout of volatility ends up exacting a toll on growth, economists believe it could spark a strong pro-growth bias, not only in developed markets but also in various emerging markets. This implies that RBI's policy decision on September 16 will be dependent on global financial market volatility.