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Too early to rejoice

It is hard not to notice the contagious excitement amongst punters about the stock markets. In a recent interview with Vikram Chandra of NDTV, Rakesh Jhunjhunwala, a Mumbai-based equity investor, excitedly spoke about his bullishness on India’s longer term future and its positive consequences on stock values. Mr Jhunjhunwala was clever enough not to commit himself too obviously on nearer term forecasts, but he did leave the impression amongst less observant viewers that the worst, for the economy, was certainly over and that the markets would sustain buoyancy in the months ahead. Other forecasters too remain eagerly optimistic with lofty claims of where the Sensex may be in the few months leading up to the Finance Budget. Perhaps it is a bit early yet, for traders, to rejoice the return of good times.

The economy certainly seems to be on a path of recovery. Demand is strong in many consumer segments such as durables, electronics and passenger cars. Cement despatches, as the chart suggests, remain robust indicating the creation of new capacities. However, credit growth halved between October 2008 and August 2009 from about 29% to 15%. This would suggest a moderation in investment and even private consumption. Why then, one would justifiably wonder, does economic data imply a firm recovery, together with sustained demand for cement and steel? The answer is government spending.

Historically, growth in private consumption lingered around the 6-6.5% mark. However, in 2007-08 it touched 8.5% before falling drastically to 2.9% in 2008-09. This fall was nevertheless compensated by a dramatic rise in government consumption (by 20.3% in 2008-09 from 7.4% in the previous year). Clearly therefore the recovery in economic performance is more a reflection of the government’s pump-priming initiatives than a consequence of a wholesome resilience in consumer demand. Several segments of the economy such as those that are consumer dependent – travel, retail, housing, etc – and exporters, continue to remain depressed. The picture, overall, remains mixed and hence rather uncertain.

Globally too the economic environment is not dissimilar. The unexpectedly early dribble of good news is mostly on account of the massive fiscal stimulus comprising of about US$2.2 trillion that was deployed so quickly alongside an unprecedented slashing of interest rates. Eventually, governments will need to unwind the fiscal and monetary stimulus of the past 10 months and central banks will focus on reducing excessive liquidity, while holding interest rates as low as possible. There is growing concern on the re-emergence of asset bubbles and having been stung recently, a firm rise in rates seems a certainty in 2010. The Reserve Bank of India, in an effort to pre-empt another bubble in the property market, only recently increased the risk rating assigned by banks to the real-estate sector. This would consequently hike the cost of funding by up to 200 basis points. A major slice of the non-food credit offered by the banking system in recent months went to real-estate. More importantly, the Reserve Bank, in the 1st quarter review of its Monetary Policy , hinted at a rise in interest rates, if inflation perks up over the next two quarters. Commercial banks sensing this possibility have clearly refrained from dropping rates despite the RBI’s abundant prodding on the matter.

Stock markets throughout Asia have jumped considerably with the Shanghai composite up 80%, Bombay up 65% and several others up more than 30%. There is understandably a growing concern that asset ‘reflation’ will lead to new stock market bubbles, as asset prices have run far ahead of fundamentals. A hike in US interest rates could trigger a reversal in foreign institutional investment inflows and the markets may correct.

In the longer term, IMA cannot dispute Mr Jhunjhunwala’s optimism on India’s growth trajectory. In the shorter term however, we remain sceptic on the performance of its stock markets which seemed to have raced ahead of corporate fundamentals that are essential in supporting them.

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