You don’t have to search very far in the markets for evidence of a slowdown—the Sensex currently is lower than where it was in September last year. And it’s only 9% or so higher than where it was at the end of September 2009. If the market is indeed a leading indicator of the economy, it seems to have done a good job of predicting the slowdown.
In the real world, of course, markets are buffeted by many factors, including the ebb and flow of global risk appetite, the level of interest rates in the developed markets and valuations. That said, cast an eye on the MSCI indices and you’ll find the India index has been one of the worst performers this year among emerging markets.
Why was India singled out for punishment? One reason was that it was a relatively expensive market. But the key to its underperformance has been very high levels of inflation. This has forced the Reserve Bank of India to raise its policy rate several times, making it the central bank that has tightened the most in Asia, after the Vietnamese central bank.
Niranjan Rajadhyaksha’s column | The exuberance was ill-timed
Anil Padmanabhan’s column | Policy reforms, monsoon key to tackling slowdown
That the tightening has led to a moderation in growth is undeniable. The quarterly numbers for real gross domestic product (GDP) at factor cost (at 2004-05 prices) sum up the story succinctly. Quarterly GDP growth has steadily decelerated from 9.4% in the fourth quarter of 2009-10 to 9.3% in the first quarter of 2010-11 to 8.9% in the second quarter, 8.3% in Q3 and to 7.8% in Q4.
But the problem with these year-on-year growth numbers is that they’re affected by a lower or higher base. So let’s look instead at the HSBC Purchasing Managers’ Index (PMI) for both manufacturing and services. These are survey-based month on month seasonally adjusted numbers and similar surveys are available for major economies globally, so we can compare trends.
The manufacturing PMI showed a slight deceleration in May 2011, while the services PMI cooled off quite a bit and was below its long-term average. Nevertheless, the reading on the composite index for both manufacturing and services was a high 57.7 in May, down from 60.7 in April. A reading above 50 signifies expansion and the composite PMI at 57.7 is still quite high. Contrast the much stronger deceleration in China, where the composite PMI had a reading of 52.8 last month. The point I’m making is that so far the PMI indices show a moderation, but growth remains quite robust.
That’s probably why the Reserve Bank of India (RBI), in its latest monetary policy statement, said there’s no evidence of a broad-based slowdown. Its optimism stems from the new series for Index of Industrial Production (IIP), which paints a brighter picture of the economy than the earlier series did. There are lots of other indications that domestic demand continues to be robust. For example, sales growth of the companies that make up the Sensex during the March 2011 quarter was higher than in the previous two quarters. Profit growth has been lower, but that’s another story.
At the same time, there are also signs of investment demand moderating, while the momentum in consumer demand too has started to flag recently. That’s reflected in the market. It is only in June that the BSE FMCG index has been a bit under the weather. In contrast, the capital goods, banking and metals indices have been falling for several months.
Anyway, what matters is not what you or I think, but what the central bank believes is the outlook on growth. And since it is of the opinion that domestic growth is fine, then that could mean more rate hikes in the future. That will result in even slower growth and RBI will be quite pleased about that. On the other hand, suppose growth does slow and RBI doesn’t raise rates any further, that wouldn’t be reason for rejoicing, simply because lower earnings growth means lower markets. So the market seems to be trapped. It’s damned if growth is strong and damned if it isn’t.
Why then have stocks moved up recently? There’s only one thing that can break the impasse in the markets—lower inflation. If inflation falls, the central bank can take its foot off the brake, consumption demand will remain strong and, operating margins will improve for firms.
And there have been a few straws in the wind recently pointing towards lower inflation. One of them is a global slowdown, which has led to lower commodity prices, seen from the fall in the global CRB Commodity Index. In fact, the recent bounce in the market has been on the back of substantially lower oil prices.
Another is China’s flash PMI for June, which shows large easing in both input and output price pressures. Because input prices are stabilizing, companies no longer need to raise output prices. In India, money market and bond yields have softened on hopes that the end of monetary tightening is in sight.
It is far too early to declare victory over inflation in India—in fact, the indications are it’ll go up even more in the next two months. And even if the central bank stops raising its policy rate soon, it may remain at an elevated level for quite some time.
But then, in the last few months, the market has dealt with inflation, rising interest rates, slowing growth, a slowdown in the US and in China, worries about a Greek crisis and has remained rather resilient.
The annual report of the Bank for International Settlements summed it up admirably: “Pessimism has become tiresome, so optimism is gaining a foothold.” But that foothold can help the markets go higher only if inflation is brought under control.
Next: Tamal Bandyopadhyay on banking and finance.