The Dow Jones Industrial Average may have sailed past the 13,000 mark to record a new high, but the fact of the matter is that the Indian market has performed much better over the past couple of months, after the most recent panic in global markets, in February. Between 28 February and 26 April this year, the MSCI US index, a broader index than the Dow, moved up by 6.1%, while the MSCI India index rose by 9.2% over the period. The MSCI Emerging Markets index has outperformed the US, which is not very surprising given that these markets had fallen more sharply during the panic. Clearly, there are few signs of investors having lost their risk appetite.
The interesting thing about the rebound in the Indian market is that it has come about at a time when the central bank has been tightening monetary policy. With abundant liquidity sloshing around in the market, it’s easy to embrace the notion that the Reserve Bank of India (RBI) has almost finished with its interest rate increases. Even after Friday’s profit-taking, interest-rate sensitive indices such as the Bombay Stock Exchange (BSE) Auto index and the BSE Bankex are above the levels they were at prior to the credit-policy announcement.
There could, however, be a reason for the market to be bullish. That’s because, as Morgan Stanley economist Chetan Ahya points out in a recent note, RBI is targeting a GDP growth rate of 8.5% for 2007-08. In view of the fact that GDP growth during the fourth quarter of 2006-07 is likely to be around 8.5%, says Ahya, where is the deceleration in growth?
If RBI’s numbers are right, then, going forward, there’s going to be no slowdown at all. Ahya puts down the 8.5% forecast to an inconsistency. “You can’t have both strong growth and low inflation,” he says. If growth remains at 8.5%, demand will remain strong, fuelling a rise in prices. In short, there’s no getting away from the fact that lower inflation will mean lower growth. That’s a message that is yet to be absorbed by the stock market.
Incidentally, the first set of monetary data for the current fiscal year shows no let-up not only in credit growth but also in the rate of growth of money supply. Here’s the data: For the year to 30 March 2007, bank credit growth was at 27.6%, which led to hopes that the rate of credit expansion was decelerating.
But that hope has turned out to be deceptive. The latest RBI figures show that year-on-year credit growth as on 13 April is back to 28.2%. Similarly, the annual rate of growth in money supply, which had slowed to 20.7% as on 30 March, is back at 21.3%. While a fortnight’s numbers certainly don’t make a trend, RBI has to fight an uphill battle to get credit growth down to its targets for FY 2008. And if these trends in money supply and lending continue, it’ll have to go in for further monetary tightening.
The reason why stocks have moved up in spite of the monetary tightening is, of course, the weight of money flowing into the markets. Fund flows to emerging markets have resumed and data from Emerging Portfolio.com Fund Research show an inflow of $4.9 billion (Rs20,090 crore) into emerging market funds in the past four weeks, which offsets almost half the outflows from these funds in the first half of March.
But while the short-term outlook for fund flows is anybody’s guess, the International Monetary Fund (IMF), in its Global Financial Stability Report published earlier this month, took a look at how cross-border financial asset accumulation had tripled in the last decade. Part of the reason: A huge growth in assets under management of institutional investors and a change in the class of assets into which this money is invested, which now include an increasing proportion of emerging market assets.
IMF says that both “push” as well as “pull” factors have contributed to these trends. The “pull” factors include new growth opportunities in emerging economies as a result of globalization, the improvement in several of these economies, reflected in a rise in their credit ratings and the opening of economies, in particular the financial sector, to foreign investors. “Push” factors include the low level of yields in mature economies, the need to seek higher returns to support older population and windfall gains accruing to commodity producers that need to be invested. Technological changes such as the ability to move money around the world in the blink of an eye and the ability to construct complex financial risk mitigating instruments have also played a part. In short, the rise in cross-border flows is not just cyclical, but includes a structural component as well. That should augur well for the long-term continuation of capital flows to emerging markets.
Nilesh Shah, ICICI Prudential’s chief investment officer, has pointed out that ratio of market capitalization of the G7 countries to that of what he calls the E7 economies (Brazil, Russia, India, China, Turkey, Mexico and Indonesia) is around 93:7, in spite of the GDP ratio being around 60:40. The trends that IMF identifies should, in time, help correct this anomaly.
Resident market expert Manas Chakravarty looks at trends and issues related to investing in general and the bourses in particular. Your comments are welcome at firstname.lastname@example.org