The market can remain irrational longer than you can stay solvent" - this apocryphal quote is attributed to Keynes. It's likely that the late Bursar of King's College never actually said this but it certainly needed to be said.
The last year or so has been one of those markedly irrational phases. Equity markets all round the world have either reached new highs in the recent past, or they are very close to new highs. At the same time, growth expectations for 2014 are being pared in most regions.
The US shutdown was resolved as the deadline came closer, as everyone expected it. The political ramifications will be debated endlessly and we could see another threat of a shutdown in February 2014. In financial terms, it means weaker US growth perspectives and that, in turn, means the Fed will continue with Quantitative Easing (QE) 3 through calendar 2013 and perhaps, through Q1, 2014. The new chairperson has a reputation for being markedly fond of easy money after all and this certainly creates expectations of a benign stance at the US Federal Open Market Committee (FOMC) meeting late this month. (Click for graphs)
At the very least, the party continues until January. That's good news for Indian equity bulls, as well as for bulls elsewhere, of course. The correlation between foreign institutional investor (FII) inflows and higher Indian equity prices is so marked that it's almost become self-referencing and self-fulfilling due to the feedback loops it has set up. It has been this way since QE3 started in September 2012. Since September 1, 2013, the FIIs have pumped in almost Rs 20,000 crore into Indian equity and their buying in calendar 2013 is above the Rs 78,000 crore mark.
US growth expectations are lower as remarked above, and Europe's growth expectations have apparently been pared, although Spain seems to be stabilising in fiscal terms. China has just printed higher gross domestic product (GDP) growth numbers than expected, at 7.8 per cent in the June-September quarter. This came on the back of higher pump-priming and it was, of course, greeted with joy.
The positive response to 7.8 per cent is one measure of how much expectations have fallen in the past two years. Global markets have now discounted the fact that China no longer registers double-digit GDP growth as a matter of course. It remains to be seen how well China's own citizens adjust to this. Some of the Chinese slowdown is due to a policy shift, from enforced saving and investment targeting exports, to encouraging domestic consumption.
India's macroeconomic indicators are proceeding on expected lines. Food inflation remains stratospheric, pushing up both consumer inflation and wholesale inflation. The Index of Industrial Production has dipped again, though it has stayed positive.
The current account deficit (CAD) seems to be reducing at speed. Legal gold imports have dipped sharply though they will rise again in October-November, given Diwali and the wedding season. The trade balance has shrunk, in India's favour, with exports rising strongly in Q2, 2013-14. The rupee also appears safer now. Reserves have risen and a fair amount - reportedly over $6.5 billion - has come through the new foreign currency non-resident swap route, though this doesn't officially count as reserves.
The Reserve Bank of India (RBI) will have leeway on the external front, assuming the FOMC meeting doesn't change status quo. In its policy review at end-October, the RBI is expected to raise the repurchase rate again, to combat inflation. But it is also expected to reduce the marginal standing facility rate and it might carry out more open market operations to ensure banking sector liquidity. The Centre is promising to recapitalise public sector banks with more than the budgeted Rs 14,000 crore in the hope of stimulating domestic consumption in the festive season.
Now for the bad news. There has been another round of downgrades to GDP expectations. Projections are now hovering in the 4.25 per cent to 4.5 per cent range or even lower, below 4 per cent. The broad implication is that the incremental capital-output ratio hasn't improved and, since the CAD is easing down, lower total investment will equate to lower GDP growth.
Good agricultural performance may change this assessment a little and keep retail consumption ticking over but perhaps not by a very meaningful amount. The Planning Commission deputy chairman assures us things will improve in October but then, he's been saying this every month for the last two years.
Earnings expectations haven't been revised upwards by much. Nor has consensus been beaten by a great deal in Q2 results as released so far. The information technology sector has revised guidances upwards but that was expected due to the weaker rupee. Crisil expects non-performing assets to rise through this fiscal and the banking results, so far, make that seem likely. The big public sector banks that have the poorest asset quality, have not yet declared results. HSBC closing its Indian broking operations is an indication that domestic sentiment has not really improved. This is also reflected in domestic institutional selling of equity to the tune of Rs 15,000 crore since September 1, 2013.
On the political front, the coal scam has resulted in the Aditya Birla Group coming under scrutiny. There have been howls of rage about this from India Inc - Kumar Mangalam Birla is respected for his probity. There are fresh developments in the National Spot Exchange Ltd scam - the chances of "infection" seem to have increased. And Walmart, of course, has pulled out.
The Nifty and Sensex have shrugged all this off and risen regardless. The Nifty is just a tad below its 2014 high of 6,230. If it crosses that, it could test the all-time high levels of 6,350, which were hit in January 2008. On the other hand, a switch in FII sentiment from these levels could lead to a massive crash. Keep your seat belts fastened but also wear a parachute.
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
