I for a long time niavely believed that picking the right stocks is the end all and be all of the investment game. However, time has taught me a lesson that the macros and the overall trend of the market impact your investment gains to large extent and you can ignore it at your peril…This is an article that i had written a few days ago of why i think that the bottom of the market is in sight and also posit that the direction of the Rupee will be the single biggest determinant of the future market direction…
These are the outpourings of an eternal pessimist. I have always looked at the bleaker side of things. However, off late, this dark view of things leads me to believe that the bottom has been reached for the Indian equity markets.
Anything that can go wrong with this Indian growth story has already gone wrong. There is an absolute lack of governance, hyper- corruption and GDP growth is tepid at best. Our public education and health systems are in shambles, our cities donât work due to a lack of infrastructure, freebies are being doled out by this government to ensure its survival without a care for the deficits. Our twin deficits are at an all time high with no sign of improving. This rupee has fallen off a cliff and looking more vulnerable by this day.
In this midst of all this gloom, this stock market has been range- bound in this 5600-6100 range. Why is it that with all these negatives, this Nifty refuses to go below 5600 mark? Have all the market participants become so lax that they donât see this imminent fall in the Nifty and have they all reached a consensus that things canât get any worse?
Let us look at the macros. The GDP growth has tapered off from the 8-9% mark to the 5% mark at the moment. This is not such a shocker as many people think. The 8-9% growth was fuelled by the wave of global liquidity in the years preceding 2008). There were no structural changes in India to support such a high growth. The receding liquidty following the 2008 US housing bubble brought India back to its sustainable growth rate of 6-7%. The fiscal stimulus after the 2008 bubble burst by the Indian government , aimed as a replacement for the global liquidity,was short lived and lacked firepower. Today, when India is muddling along at 5% GDP growth, we are only about 1-1.5 % off our sustainable growth rate and not 3-4% as most participants assume. To grow at 8-9% , India would have to undertake deep structural reforms like education, healthcare, judicial, police, land reforms etc. Tinkering with FDI limits will not get us there.
The present slowdown in the growth is due to lack of both private and govt investment. Govt investment has slowed down as the govt is so hemmed in by the fiscal deficit, that it has very little elbow room left for any meaningful infrastructure investment. The money that the govt has is being spent on wasteful subsidies like fuel, MNREGA and now the latest food security bill. These schemes are in no way resulting in sustainable infrastructure development and the consumer spending resulting from these schemes will be fleeting at best.
Private investment has slowed down because of the private sector not being sure what the rules of the game are. The policy making by the present govt has been such a mess that no businessman is willing to bet money on a project which might never see the light of the day. This could be due to issues on the land acquisition front, environmental clearance, change is policies retrospectively and no hope of the govt taking timely decisions. The greatest example of this policy paralysis is the UMPP projects. Many have been shelved, but of the two operational projects, both are bleeding due to the inability of the govt to take the decision to pass through the increased cost of imported coal. Which businessman in his/her right mind would invest money in such an uncertain environment?
To cater to this lack of lack of domestic demand, the FM is trying to woo foreign capital in the form of FDI and FII.
FDI participants would have the same issues as the Indian investors have and are unwilling to invest. This is evident from both the dropping FDI month on month and also the lack of any takers for the recently opened up sectors. Multi brand retail is an example of how not to lay down policy. From letting the states to decide to let in the foreign retailers,to complex sourcing laws and just all around confusion. There has not been one dollar of investment since this announcement had been made in Sep 12.
FIIâs have been a lot more generous to India in the recent past. They have poured in billions of dollars in both the debt and equity markets. These investors are more insulated to the issues on the ground and are willing to invest in Govt bonds or shares of well run Indian companies. They also know that the money can be withdrawn at the click of the button and the extra risk that they take by investing in India can be compensated by higher returns. However, this flow is also under threat due to the weakening rupee.
Before we go any further, let us take a look at India current account deficit. This deficit means that we import more than we can export. India being an energy deficient country , needs to import almost all of its energy needs. This coupled with the imports of edible oil and pulses makes up for a huge import bill. I am not including gold as a part of this as it is a non-essential need and hence more elastic.
To pay for these large imports, we need to export an equivalent amount of goods and services. We are unable to do that. The reason for this is simple. India is not competitive globally to export goods and services that the world wants. Besides IT services and pharmaceuticals there is hardly anything that the world wants from us. The resultant gap in imports vs exports is putting pressure on the Indian currency and it has depreciated by around 11% from the beginning of the year. The resulting rupee depreciation is in turn increasing the CAD thereby turning into a vicious circle.
The govt hopes to fund this deficit by a combination of FDI, FII and inward remittances. NRI flows will continue to sustain families in India and also invest in real estate to chase higher returns. FDI as we saw is declining. This leaves us with FII flow as the only saviour.
Let us examine the source of the FII flows and what can prompt this money to flow out of India. I believe that it is the FII flows which are propping up the Indian stock market. This theory is also supported by the fact that the domestic mutual funds have seen redemptions, every time the stock market has moved up. This clearly shows that the Indian investor has very little belief in the Indian growth story.
The Quantitative Easing undertaken by the Fed, European Central Banks and the BOJ has resulted in trillions of dollars flooding the world markets. With the interest rates at historic lows, this money had to look for avenues to generate returns. A lot of this money went into the developed stock markets and this is evident from the excellent returns that the US, European and the Japanese stock markets have shown. A small fraction of this money also found its way into the emerging markets to chase higher returns and to also diversify the investment portfolio.
For the Indian markets to sustain this level or to move higher, it is imperative that the FII flows donât get reversed. What can prompt this money to flow out? The biggest factor which can prompt this is if the central banks give out signals on the withdrawal of QE. The stop of the easy money will force the money managers to treat this money with more respect and conserve the capital that they have. The EMâs would be the first to bear the brunt of this withdrawal and will see a serious contraction in their value. How likely is this event to occur in the next 6- 12 months? All the central banks have made it clear that they intend to continue with this policy till they see a sustained growth in the GDP growth of their respective countries. US is showing some signs of coming out of the ICU but it is still early days. It is unlikely that the Fed will put the recovering patient on a strict diet thereby jeopardising its health. Europe and Japan show no sign of recovery.
Under these circumstances, it is fair to assume that the QE will continue for the foreseeable future. What else can prompt the FIIâs to withdraw? The other reason is that if the risk- reward equation is hopelessly skewed towards risk. The rupee depreciation has done just that. With the rupee in a freefall, the international investor not only has to make an investment return by making the right calls but also to compensate for the rupee fall to make any return in dollar terms. This is becoming a tall order with the rupee falling so quickly.
To sum it up, the future of the Indian stock market now rests on whether the rupee achieves stability or not. If the RBI and the govt. manage to do this, then we are set to make new highs in the next 9- 12 months and this could be a great time to be investing in India. A further weakening of the rupee will queer the pitch and result in new lows.
I for one will be keeping a keen eye on the rupee to make my investment decisions. An appreciation upwards to Rs 56-57 to the dollar is great news and depreciation to Rs 63-64 is a sign to sell and accumulate cash.