The volatility in India’s financial markets is a consequence of fears within the euro-zone. The Bombay Stock Exchange’s sensitive share index has yo-yoed over the past few weeks with brief spells of euphoria marred by successive stretches of gloom. It is hard for market analysts to determine, even within liberal bands, the possible direction that markets will take in the weeks and months ahead. Be that as it may, recent figures released by the government suggest that the economy has performed better than expected, with growth a few notches higher than previously forecast. The rise in GDP for the past fiscal year is now stated to be 7.4%, supported by strong results in industrial manufacturing (9.3%) and even a marginal rise in the agricultural sector (0.2%).
But this good news comes with a caveat. The economy lacks fundamental support within two important domains. First, private consumption is uninspiring with a moderate increase of 4.3% against an average of 8.5% witnessed in the previous four years. Second, exports continue to be encumbered with feeble demand in Europe and a fragile recovery in the United States. Whilst these factors do influence the economy, a greater risk involves the availability of capital and its cost. The Reserve Bank recently hinted that it intends to revert to a hard monetary policy to tackle the rise in inflation. Going forward, therefore, we should expected liquidity to tighten, coupled with a hardening in interest rates.
Uncertainties in the Euro-zone have had punters on tenterhooks. Capital outflow from India was USD 1.7 billion in May with unfavourable consequences on the Sensex and exchange rates. Both have subsequently come under a bear-hammering. There is historical evidence to indicate that in times of turmoil, investors panic and withdraw from emerging markets to take refuge in the US dollar or commodities such as gold. Consequently, both have observed exceptional and perhaps illogical rises over the weeks. Many believe that the euro will soon settle on parity with the greenback. The withdrawal of capital affects liquidity, effectively new investment and as a result, economic growth.
The volatility in Europe will linger for several months. A brave rescue parcel offered by the European Union notwithstanding, investors remain unconvinced that the problems will go away in a hurry. They conclude things will actually get worse before they get better. The markets are probably right, as Greece will be unable to meet the stringent conditions imposed by the EU/IMF bailout package. In any event some economists believe it will be all but bankrupt again in three years. Its economy simply cannot recover with curbs on spending, higher risk premiums, expensive debt and high rates of unemployment. Yet, all of these are essential in bringing normalcy to its fractured business environment, caused by years of indulgence. Other nations, such as Ireland, Spain and Portugal, too, are in the grips of severe financial problems and, as we argued in our recent paper “Euro Crisis”, will not come out of them without tolerating unreasonably high rates of unemployment.
Going forward therefore, India’s predicaments are as much a consequence of her own monetary policy, as they are of the global financial markets. The flight of risk capital, if it were to occur, would leave small and medium enterprises starved for funds. Banks usually become risk averse in time of volatility, clamp down on disbursements, or in the least, offer terms that are simply too excessive to make commercial sense. Even now, CFOs complain, banks are beginning to behave awkwardly – hardening their stance on terms of loan agreements that they are willing to sign. It is possible that India may face a double dip, although for now we are prepared to allot this a probability no higher than 25%.
But this good news comes with a caveat. The economy lacks fundamental support within two important domains. First, private consumption is uninspiring with a moderate increase of 4.3% against an average of 8.5% witnessed in the previous four years. Second, exports continue to be encumbered with feeble demand in Europe and a fragile recovery in the United States. Whilst these factors do influence the economy, a greater risk involves the availability of capital and its cost. The Reserve Bank recently hinted that it intends to revert to a hard monetary policy to tackle the rise in inflation. Going forward, therefore, we should expected liquidity to tighten, coupled with a hardening in interest rates.
Uncertainties in the Euro-zone have had punters on tenterhooks. Capital outflow from India was USD 1.7 billion in May with unfavourable consequences on the Sensex and exchange rates. Both have subsequently come under a bear-hammering. There is historical evidence to indicate that in times of turmoil, investors panic and withdraw from emerging markets to take refuge in the US dollar or commodities such as gold. Consequently, both have observed exceptional and perhaps illogical rises over the weeks. Many believe that the euro will soon settle on parity with the greenback. The withdrawal of capital affects liquidity, effectively new investment and as a result, economic growth.
The volatility in Europe will linger for several months. A brave rescue parcel offered by the European Union notwithstanding, investors remain unconvinced that the problems will go away in a hurry. They conclude things will actually get worse before they get better. The markets are probably right, as Greece will be unable to meet the stringent conditions imposed by the EU/IMF bailout package. In any event some economists believe it will be all but bankrupt again in three years. Its economy simply cannot recover with curbs on spending, higher risk premiums, expensive debt and high rates of unemployment. Yet, all of these are essential in bringing normalcy to its fractured business environment, caused by years of indulgence. Other nations, such as Ireland, Spain and Portugal, too, are in the grips of severe financial problems and, as we argued in our recent paper “Euro Crisis”, will not come out of them without tolerating unreasonably high rates of unemployment.
Going forward therefore, India’s predicaments are as much a consequence of her own monetary policy, as they are of the global financial markets. The flight of risk capital, if it were to occur, would leave small and medium enterprises starved for funds. Banks usually become risk averse in time of volatility, clamp down on disbursements, or in the least, offer terms that are simply too excessive to make commercial sense. Even now, CFOs complain, banks are beginning to behave awkwardly – hardening their stance on terms of loan agreements that they are willing to sign. It is possible that India may face a double dip, although for now we are prepared to allot this a probability no higher than 25%.
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