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Sumant Sinha Image

Prasanna, who helps with the housework at my parents’ home in Delhi, told me on my recent trip there that he had put a substantial part of his savings into the stock market. Not only that, he had also borrowed from a friendly bank to leverage his investment. The recent correction, needless to say, has not been kind to him. Faced with a significant monthly amount to repay his loan, he asked me, in a bewildered sort of way, if the “companies” had taken his money away.

Whether this incident is reflective of the typical Indian retail investor, I really don’t know. What is clear is that when uninformed retail investors like Prasanna invest in the market and get burnt, then the top of the market is likely behind us. This is because while, at different points in this bull run, Middle East money and Japanese investors came in and drove the market higher, it is finally the retail investor who provides the last bid. Now there has been a correction of almost 20% from the high point and while we have benefited significantly from global liquidity and low interest rates, the global environment has turned less benign. It remains to be seen how this will impact foreign institutional investment (FII) flows into the Indian market.

What are the factors that have turned the tide from a favourable to a less hospitable environment? For one, higher interest rates had to begin to impact the global economy at some point. This appears to be finally happening. In fact, we seem to be moving into a higher inflation, higher interest rate regime, the world over. The three major central banks—the Bank of Japan, the US Federal Reserve, and the European Bank—appear to be tightening simultaneously. The US has, of course, been on this path for a while, with little apparent impact so far. But, finally, the US housing market appears to be cooling. Commodities, on a tear so far, partly driven by fund activity, also appear to have reached saturation point as far as prices are concerned.

So, we now have a situation in which various asset markets—stocks, real estate and commodities—appear to have peaked. The phase of consolidation, if we are lucky, begins now. In the global asset allocators’ scheme of things, emerging markets like India are lower quality, high beta investments. In other words, they are great to get into when times are good, but should be quick to exit when the market reverses. Within the emerging markets’ asset class, India, with its sound economic story and transparent markets, has been a preferred choice. But in the markets’ consolidation phase, we should not expect to escape the brunt of reversing FII flows.

Having said all this, let’s clearly separate the stock market from the real Indian economy, which continues to be on a roll. The GDP growth number of 8.4% for the last financial year and 9.4% for the last quarter are terrific. Clearly, the economy has strong momentum. Confidence levels are still high and the private sector will invest aggressively, even as consumers continue to drive the economy. To my mind, infrastructure growth should be much better going forward, and so should sectors such as metals and power, which have under-performed up to now.

• World over, movement is to a regime of higher inflation & interest rates
• Stocks apart, the real Indian economy continues to be on a roll
• However, we are certainly moving to a more difficult macro environment

Nevertheless, there are a few clouds on the horizon. The first is the threat of higher inflation and the consequent impact on interest rates. With FII money being pulled out, there will be downward pressure on the rupee. This might stoke inflation, which eventually will lead to higher interest rates. This will have a significant negative impact on the economy, as higher rates influence both consumer and corporate spending. Second, higher oil and commodity prices in general do not look like going away. At some point, the economy will have to absorb this cost, and doing so in a higher interest-rate regime will be tougher. Third, we have the uncertainty of the monsoons and the consequent impact on agricultural growth and rural consumption, which cannot be underestimated.

It appears to me, then, that we are moving into a more difficult macro-economic environment, which will keep our policy makers on their toes, going forward. The easy pickings from a growth and market perspective, my friends, are now behind us. From here on, it is only further and sustained economic reforms that will drive growth.

Source: The Financial Express