Complexity of global macro economics playing out has led to the recent volatility and is likely to remain so in the near future. Developed economies are fighting deflation, whereas emerging markets are fighting inflation. In such situation, global policy co-ordination and trade co-operation has increasingly become difficult. It will be in global good that the US/Europe start growing back but that looks a bit distant dream to me. In the absence of growth, easing will continue, which may lead to higher global commodity prices and in turn cause upward pressure on inflation and exchange rates in the emerging economies, forcing them to put some amount of capital controls or actions to fight inflation.
For example, in case of India, almost 300 basis points of the current level of 8.6 per cent inflation is contributed by imported non-food inflation and therefore any spike in global commodity prices may derail the softening trend in inflation. The fear is that if imported non-food commodity prices continue to rise, RBI may be forced to re-look at its announced policy of a pause in the rate tightening cycle.
However, the risks to the outlook persist. Without sounding party popper for the India growth story, I think there are some serious concerns facing us. Inflation and huge current account deficit are two biggest worry points we have. Inflation is unlikely to come down in a hurry and easy monetary policies of developed world will put pressure on commodities. RBI will have to resort to tightening, which will impact investment cycle.
In this global macro context, I would like to evaluate how Indian markets will perform in near to medium term. No doubt that we have long term growth story in place. Some of the positives are robust economic growth, strong domestic demand, strong banking system, robust corporate earnings growth and huge institutional inflow.
In my opinion, in near-term there are a lot of headwinds for equities. Risk to my hypothesis is if RBI allows unchecked flow of funds into the markets and does not resort to tightening, though I see a low probability of the same.
Against this uncertain environment, it is hard to foresee immediate positive triggers for various sectors. Banking sector is over-owned and seems to have peaked out. Consumption oriented sectors can continue to deliver healthy growth. I remain positive IT sector as it is delivering growth and a natural hedge against rupee depreciation. I also expect portfolio allocation to get skewed towards defensives like utilities, oil & gas, which should protect the downside in uncertain environment.
The author is EVP, Institutional Equities, Edelweiss Securities
