Market triggers

Dollar, political stability and reforms will determine the course of the market in the current fiscal

By Mohan Sule

Now that the market has discounted the March 2011 quarter results and normal monsoon forecast, what will be the next triggers in the coming fiscal? The most important indicator will be the pace of foreign fund inflows, which had slowed down early this year on the strengthening rupee, but returned end of the last quarter on the weakening of their borrowing currency, the yen. Since the collapse of Lehman Brothers, resulting in recession in the developed economies and slowdown in the emerging markets, it is now clear that movement of funds into and out of a country is not solely dependent on its economic health. Many external factors such as currency equation, availability of cheap credit and valuation of assets in comparison with investment opportunities elsewhere figure prominently. Here, the moves of Federal Reserve chairman Ben Benanke will have to be followed. So far he has resisted calls to release US interest rates from the near-zero level due to anxiety that any steps to rein in the rearing inflation could be at the cost of the incipient recovery. Yet, end April, he announced the phasing out of the second installment of quantitative easing, or liquidity injection, by June, which could put pressure on interest rates and boost the dollar, a requisite to attract investment into the US. These are indeed contradictory signals. The US needs a weak dollar to boost its exports. At the same time, it cannot ignore pressure from China, its largest creditor, which holds most of its foreign exchange reserves in dollars. For the currency market as well as for companies selling overseas and importing raw materials and components this translates into volatility.

A strengthening dollar, however, will be good news for exporters to the US, particularly China and India. Tech companies, facing rough weather of late due to the weak recovery in the US, could be the biggest beneficiaries as long as the American economy does not blink in the process. Besides currency, foreign funds prefer countries with stable government. The world is not looking particularly attractive in 2011. Earthquake off Japan has set back the third largest economy at least by a couple of years. Oil is heating on unrest in the Arab region. A year ahead of change at the top, China’s present leadership has unleashed an unprecedented wave of repression to crush any signs of Jasmine revolution. The Chinese intend to decelerate over the next few years to insulate the country from overheating. How will the restless population, used to their economy expanding at an average 10% over the last decade, take to a growth rate of 7%? If the Chinese government can manage this transition “harmoniously”, the recent correction in surging prices of oil and base metals will sustain unless India, expected to gallop at 9% this fiscal, steps in as a substitute. The government is stable but has been weakened politically due to the various scams. It is doubtful if it has the appetite to undertake second-generation reforms including allowing more foreign investment in insurance and opening the retail sector. Even the announced aim of collecting Rs 40000 crore through PSU divestment looks ambitious: it was able to mop up Rs 22000 crore last fiscal as against the target of Rs 40000 crore despite a buoyant market and absence of any political danger.

Slowdown in foreign fund inflow against the backdrop of recovering US and EU economies too could make it difficult to get attractive valuation. The picture could reverse, if the government takes the bold step to sacrifice some amount of premium to bolster the domestic market. It is not only PSU stake sell-off that will be required to keep the economy humming. How the besieged government tackles subsidy will be interesting to watch. Petrol prices have been raised seven times totaling Rs 10 per litre last fiscal and another hike is in the offing now that the assemble elections to the five states are over. Oil marketing companies could get some more relief but will continue to incur losses. Fertiliser stocks have been looking up of late not only in anticipation of good rainfall but also on hints of freeing urea pricing. The firmness of resolve will depend on which way the results to the five state elections go because cutting the subsidy bill is bound to contribute to inflation. Not only that, awarding of infrastructure contracts, which have been picking of, too, will suffer if the government turns lame-duck. High interest rates, surging commodity prices, and a freeze on reforms and the resultant impact on foreign portfolio investment pose a challenge that could unnerve even a competent government. The baggage of corruption will make the task even harder if painful but necessary measures to keep the economy on course are viewed with suspicion by a cynical population or worse paralyses decision-making.

Mohan Sule