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Global factors spell trouble for the stock market

Last updated on: August 11, 2014 12:03 IST


One of the issues about managing an open globalised economy is that trouble can arrive out of left field. 

While World War II historians are familiar with Donetsk, Luhansk, Sverdlovsk, Kharkiv and other dots on the map of the Eastern Ukraine, it is unlikely that too many members of the current Indian Cabinet have much acquaintance with those parts.

Yet, trouble in those regions was responsible for the loss of market value on Dalal Street in the last week.

In World War II, the East Ukraine was one vast battlefield - Donetsk itself saw as many as five battles between 1941 and 44 - as the Germans invaded the Soviet Union, and were then driven out. 

The Great Patriotic War, as the Russians refer to it, was an existential struggle between two ideologically opposed regimes. Tens of millions died before Stalin came out on top.

The conflict now raging is of relatively minor dimensions. But it could have serious consequences for global order and it could, in certain scenarios, scale up considerably. 

The Ukrainian republic has used artillery and air strikes to support actions by armour and mechanised infantry against rebels of Russian ethnicity. But those rebels, backed by Vladimir Putin's regime, are clinging to their strongholds.

Russia has amassed a large force on the border (after having annexed the Crimea) and there are fears that it could invade in support of the rebels. It's an open question whether NATO would be prepared to resort to direct military action if Russia did intervene. That would mean escalation in the direction of the worst case scenarios.

As of now, the European Union (EU) and the US have announced punitive sanctions against Russia, including sanctions directed against specific oligarchs, and against the Russian banking system.

Russia could well retaliate by cutting off energy exports to the EU. Western Europe is seeing a fragile recovery and Russia's economy is not in great shape.

Concerns about West Asia - Gaza, Iraq and Syria - accentuate fears of a fuel squeeze. The Chinese Central Bank has reportedly postponed its informal moves towards making the yuan fully convertible by 2015. 

So this situation has resulted in risk-off behaviour from global investors and that brings us back to Dalal Street by way of the Kremlin, Shanghai and Brussels.

Foreign institutional investors (FIIs) were net sellers of Indian assets through the past fortnight. Domestic investors were net buyers. The equity mutual fund industry got a big boost as Assets Under Management rose by over Rs 10,000 crore in July. This suggests retail investors are still bullish despite net selling from retail investors who hold equity directly. 

The good news on the international front is that the US economy seems to be strengthening. The latest labour data beat estimates comfortably with a lower-than-expected unemployment number.

The Federal Reserve will continue to taper the Quantitative Expansion III programme but it has sounded several notes of caution about the state of the US economy. 

Mirroring the US Fed, the Reserve Bank of India (RBI) also kept its stance more or less unchanged, with a very minor cut in the statutory liquidity ratio. The Indian central bank professed to be satisfied with the trend of inflation.

It is targeting retail inflation of eight per cent or less by January 2015 and the latest Consumer Price Index (CPI) is at 7.3 per cent. But it remains cautious in the face of external crises and the possibility of a sub-par monsoon. 

The central bank's estimates for full-year growth also remain unchanged. Reading between the lines, RBI will wait to see how effectively the new government manages food inflation and also whether there is significant acceleration in infra project activity as promised by the Modi sarkar. The former impinges on the CPI while the latter could have a big impact on non-performing assets. 

A rate cut now could have been welcomed by some corporations. However, it could also trigger rupee depreciation and that would really hurt if crude prices also spiked. Quite a few Indian corporations will struggle to meet external debt obligations if the rupee dropped significantly. 

There has already been some pressure on the rupee due to FII selling and end-of-month dollar demand from crude importers. Hopefully, this may be temporary.

If the rupee does slide, there will be a certain amount of interest in information technology stocks. Most currency traders have developed a reluctant but healthy respect for Raghuram Rajan's ability to manage currency fluctuations and sustained rupee selling is unlikely. 

There has been some disappointment and puzzlement about the World Trade Organisation stance and India's refusal to sign the trade facilitation agreement. The lack of any substantive outcomes from US Secretary of State John Kerry's visit is also mildly disappointing, though the scuttlebutt is that some announcements may be planned for the PM's US visit. 

The Q1 corporate results have, by and large, confirmed that the economy is making a slow recovery. Projections suggest that major acceleration is unlikely in the July-September quarter. Meanwhile, the Vedanta-Cairn-Sesa Sterlite affair is indicative of the standards of Indian corporate governance. In a different way, so is the alleged Syndicate Bank-Bhushan Steel nexus. 

The initial euphoria about "acche din" has died down. It's business as usual for the National Democratic Alliance. It needs to pass legislation on the foreign direct investment front and in labour laws to demonstrate that it can actually utilise the mandate it received. It needs to deliver greater efficiency in bureaucratic processes. 

The market is precariously poised. If there is a further escalation of the Ukraine crisis, it could nosedive regardless of what happens to India's economy. Otherwise, it is likely to continue range-trading until some sort of major trigger is visible.

Devangshu Datta