India inches towards deflationary economy

China’s National Bureau of Statistics has announced that the nation’s consumer price index fell 1.6% in February from a year earlier, the first year-on-year drop in more than six years. Meanwhile, the producer price index in February dropped 4.5% from a year earlier, a steeper fall than January’s 3.3% decline.

With China officially announcing its entry into a deflationary economy, India is close on the heels to follow suit. After witnessing months of increasing inflation, people may sigh relief to see a sharp decrease in inflation but they are in for a much bigger surprise. India is soon moving into deflation zone!! But is it really a sign of relief when we are witnessing a slowdown in economy ? It may actually start a new series of trouble for the economy and drift the growth rate down further

Deflationary Economy & India

• Deflation occurs when Inflation rate falls to below Zero %. As per last data released India’s Inflation stood at 3.03 % as against 12.9% in August 2008.
• Experts are of view that India will reach deflation by Apr’09. This will be India’s first face-to-face wit deflation after March, 1976.
• The fall in inflation is primarily led by falling crude prices and commodity prices.
• Though a deflationary trend might be a welcome move for the government in an election year, this would induce further slowdown in economy if not dealt with properly

Impact of Deflationary Economy

What happens when an economy moves into deflationary trend ? For people like us, who have been born and brought up in a inflationary economy, the realities of deflationary trends might require us to understand the real impact. Deflation in commodities bring a shift in consumer buying pattern and people start deferring their buying in anticipation of further price drops. This is true even for Investments as people tend to hoard cash instead of investing in securities as they fear that the value of their investments would depreciates. This is turns stalls the growth of the economy. In this situation Banks would be forced to further reduce their lending rates to drastically low levels (even to zero if deflation persists for a long duration).

However, deflationary trends in India are expected to remain till end of the year as it counts on its ever increasing population to counter the evils of slowdown and bring back faster pace of growth. What would finally happen, lies unfolded in the arms of the Future, but India needs to prepare itself to counter with this phenomenon in such a way that the impact on growth is minimal.

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UPA win may help in changing Market Mood

UPA wins trust, Can market win Investors ?
It was a nail biting finish to the Vote of confidence moved by the UPA government. The 45 minutes of delay in counting in 50 votes nearly stopped the breath of both the ruling and opposition parties and finally UPA managed to emerged as a stronger combination.

Expectation from the New UPA

Now with the change in composition of UPA and as the anti-reform brigade of the Left is out of the scene, the Prime minster is expected to move faster on the various initiatives to put the country on the fast growth track. This includes signing the Nuclear deal, moving faster on Infrastructure growth, bringing Insurance and banking reforms. Now this is a good news of market. Will the government gear itself to get rid of the inflationary pressure on the economy and put the country back on growth radar ? The road may not be so smooth but in short term the UPA win of course would be a moral booster for the sensex.

Impact on Stock markets
Today's rally indicated that markets were confident of the UPA win and the outcome is going to give a short term relief to the markets in terms of positive sentiments. But all depends on how the government presents itself to the investor community post its rebirth.

The bigger evils like inflation and lower IIP are not going to die down soon and government doesn't have magic stick to ward them off. Hence, the sober mood in market may not last long. Also the new partners in UPA may pose new set of challenges to the party, hence , politically also things cannot be termed to have settled till May'09 when the elections are due.

In summary, the coming week would be interesting to watch as sensex find some reason to celebrate on one hand and gets reminded of the lingering issues on the other. Read More!

Global & Domestic cues continue to haunt

Markets still in Red Zone

For those who are getting a comfort factor with this week’s dramatic rise of sensex, I do not have a good news to share. The sentiments still remain shaky for the markets and the macro environment is still having a negative bias.

Yesterday, I was thinking about the way Indian markets are behaving and a question that came to my mind was “Are Indian markets too emotional”? or in other words “Are Indian markets too irrational “? Irrational markets typically display bouts of extreme volatility both on positive and negative side and we have witnessed similar pattern in last one year or so. Initially the market was swamped with positive “bias” and went on rocketing to 21K levels as if there was no tomorrow and this year what we have witnessed is the other face of it i.e., Negative “bias” followed by global concerns, Inflation and political instability.

What went wrong ?
What are markets? We say markets have negative /positive bias. But what is market made up of? Aren’t they made up of Investors who put in their money for a better return? So If I say markets are displaying irrationality, doesn’t it mean that the Investors in Indian markets are showing immaturity or lack of understanding about the macro environment. The market statistics are nothing but sum total of Investor behavior as depicted in their buying and selling patterns. A major factor that drives Indian and other emerging markets is that FII’s are a major force in driven the market behavior. So do we say that FII’s have realized that these emerging economies may not satisfy their hunger for quick bucks and are fleeing the scene? Were they caught on wrong footing? Did they overestimated the potential of these economies?

If one see the pattern of Indian markets vs. US markets (In the above chart Nasdaq trend is depicted in Blue, Sensex in Red and Dow in Green), it is visible that even though the global factors are weighing heavily on the markets, most of the bad news is emerging out of the US, the US markets have shown more maturity in terms of movement of their indices. While US markets are down only 14%, Indian markets have tanked by more than 30% during the same period.

FII’s are still selling, MF’s do some shopping

If we looks ate the current pattern of Investments of FII’s and mutual funds, FII’s are still selling heavily. They have already sold 6 Billion worth of stocks on a net basis in this year. The month of June saw second highest selling after January’08. Mutual funds came out to do some shopping in June and are net buyers even in July so far, but the volumes is much low as compared to FII’s. Moreover, Mutual funds has also not being major buyers in the stocks and hence are not able to provide major support to the indices. HNI' had been reported to already cut down their exposue in equity markets significantly. One thing is very clear, If markets have to go up strongly Institutional interest is a must. In the current circumstances this doesn’t seem to be the case and hence any short covering (or say technical correction) should not be read as resumption of buying interest in the markets.

Crude is down but not out

The crude oil surge showed some signs of cooling (currently trading at $128.5) after hitting highs of $145 in July. Experts are of the view that this might be a temporary correction. I have been reading various articles on crude oil and the common consensus is that the crude at settle at $100 levels by the end of this year. Any increase in crude prices from here would act as negative news for the markets. I have explained in one of my earlier post as how rise in crude oil aids in increasing the inflation and hence Inflation which is another big dragger of the markets would also get help if crude cools off faster.

Domestic cues are Negative
Morgan Stanley has revised its GDP growth estimates for India down from 7.4% to 7.1% for FY09 and from 7.8% to 7.6% for F2010. Rating Agency Fitch has revised its local currency grade outlook for India to negative citing deteriorating public finances, mainly due to subsidies (Read the article in Reuters )

As expected, Inflation rose marginally to 11.91 as compared to 11.89% last week. Analyst are of view that Inflation might touch 12% before settling down at the end of the year or early next year.

However, there is good news on the Corporate tax and direct tax fronts. Belying fears of slowdown in economic growth affecting government revenue, direct tax collections have grown 38.6% to Rs57,373 crore in the first quarter this fiscal. Corporate tax collections rose 32.65% to Rs34,566 crore for April-June period this fiscal, against Rs26,058 crore during the corresponding period last fiscal.

Political drama continues and the coming week is very crucial in deciding the fate of the UPA government. The confidence motion on Tuesday would decide the short term trend in the market. The fall of UPA government may add to the woes of market as it may lead to further pull out by FII’s. However, the general opinion is that the UPA would manage to save its face.

Investment Guru’s Outlook
My opinion remains same as I gave in my previous post on market outlook. The sentiments are still negative and one should not expect markets to zoom. However, at the same time, long term investor should cherry pick fundamentally strong companies for investing with at least 1 year horizon.

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