A bigger danger for the economy now is a possible cut in sovereign ratings

A bigger danger for the economy now is a possible cut in sovereign ratings
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First Published: Mon, Jun 23 2008. 07 20 AM IST

Updated: Mon, Jun 23 2008. 07 20 AM IST
Last week’s shock was inflation—stocks and key indices tumbled and market sentiment faltered, as inflation topped everyone’s expectations at a 13-year high of 11.05%. The market was no doubt bracing for inflation numbers to go up, but they expected it to be between 9.75% and 9.98%.
Inflation at the level it came in jolted the market on Friday and panic gripped the bourses on concern this would have a knock-on effect on the Indian economy, which is already struggling to maintain its growth targets.
Indeed, inflation at the current level is scary for everyone. Aside of the domestic implications of an expected monetary tightening including a hike in interest rates and the percentage of deposits commercial banks need to keep with the Reserve Bank of India, it also raises the spectre of a lowering of India’s sovereign rating.
That is a bigger danger now for the Indian economy as the current account deficit is also growing, and taking all current economic indicators, including the depreciating rupee into consideration, there could be enough to point to a downward revision of India’s sovereign rating. If that happens, there would be real trouble for the Indian economy and stock markets as this could trigger greater outflow of foreign funds and a drop in foreign direct investment.
Indian inflation is already among the highest among emerging economies and in Asia—in fact, it is second only to Vietnam. With this week’s leap in inflation, we have overtaken countries such as Indonesia (inflation at 10.38% in May), the Philippines (9.6%) and Singapore (7.5%), and this dents our economic credentials considerably.
Panic room: Traders at a stock brokerage in Mumbai on Friday. Stocks and key indices tumbled and market sentiment faltered, as inflation topped everyone’s expectations at a 13-year high of 11.05%. (Photo: Punit Paranjpe/ Mint)
The markets will probably wait and see what the government will do next as damage control. Though a lot of measures are being discussed, including tax cuts and monetary tightening, it’s unclear how these would help. As of now, the positive sentiment, which started building after better- than-expected industrial growth and a bumper rise in direct tax collection, have completely been overshadowded by inflationary fears.
Globally, too, inflation continues to dominate sentiment. However, last week the PPI (producer-price index) numbers in the US were a pleasant surprise as it came in as per expectations, lowering fears of boiling inflation in the world’s biggest economy. Also, hopes that the interest rates in the US may not be hiked comforted the US economy. But the warnings of more mortgage-related write-downs at banks reignited investor fears of worse to come—triggering a fall on the US bourses. Also, rumours of profit warnings by Merrill Lynch and Co. Inc. and other investment banks led to sell-offs in the stocks of financial companies.
Oil—the biggest villain on the bourses—shot up yet again on Friday after tensions in West Asia and a weak dollar further aggravated fears about inflation and consumer spending. Finally, at the close of the week, the US bourses were at the crossroads with a downward bias.
This week is very important for the US as the crucial meeting of the Federal Reserve is scheduled on 24-25 June, which will reveal the Fed’s monetary stand and its interpretation of inflation and the general economic condition in the US. Though, going by the interest rates futures, it is almost certain that the interest rates would remain unchanged in the US at 2%, any hawkish comments by the Federal Reserve chief on monetary policy would be negative for stock markets globally.
This week, US stocks are also likely to reel under news related to more write-downs from bad mortgages, a cut in dividends and the raising of fresh capital by banks. However, on the positive side, the meeting of the Federal Reserve could give some reprieve for the markets if any policy announcement strengthens the dollar. Any cooling off in oil prices will be a positive development for global economies, which are under tremendous pressure due to oil inflation.
Other than the meeting of the Federal Reserve, some important data lined up in the US this week include the building permits number, durable goods orders and new home sales for May—all scheduled on Wednesday. On Thursday, the final reading on first quarter gross domestic product and initial jobless claims will be released.
On the same day, existing home sales data for May will also be watched keenly, especially after the resurgence of mortgage-related write-downs by banks last week. Overall, it will be a critical week in the US, with all eyes set on the outcome of the meeting of the Federal Reserve.
As far as the Indian economic calendar for the week is concerned, there is not much on the horizon. However, the weekly dose of inflation on Friday will be the most sought after data, which may give some direction to the market.
Technically, the market outlook seems weak with more declines in the offing after the sharp turn in sentiments on Friday. Since any announcement by the government could affect this, news related to monetary measures and other tactics related to controlling inflation will be watched carefully. However, going strictly by technicals, the previously mentioned level of 13,747 points still holds as a very strong support level for the Bombay Stock Exchange’s Sensex. Under normal situations, the markets should bounce back from this level.
However, if the inflation scare continues, then the market could see further lower levels. On the upside, the Sensex is likely to witness its first resistance at 14,807 points, followed by the next resistance at 15,073 and a strong level at 15,391 points. If the Sensex closes above this level, then the sentiment will turn positive. However, small investors should largely refrain from this type of market, while long-term investors could take this as an opportunity to pick up bargains in small lots.
This week on our technical radar are stocks such as Tata Power Ltd, Sterlite Industries Ltd and Mahindra and Mahindra Ltd. Tata Power at Rs1,252.20 has a target of Rs1,305 and a stop-loss of Rs1,212. Sterlite Industries at Rs767.70 has a target of Rs798 and stop-loss of Rs731, while Mahindra and Mahindra at Rs574.20 has a target of Rs593 and a stop-loss of Rs555.
From our last week’s recommendations, Lanco Infratech Ltd touched a high of Rs415.75, which was well above its target of Rs376, registering gains of around 16% over the recommended price of Rs359. Praj Industries Ltd, recommended at Rs185.30, touched a high of Rs203.90, which was well above its target of Rs198. And Reliance Capital, recommended at Rs1,130.45, touched a high of Rs1,204.7, against its target of Rs1,174.
Vipul Verma is a New Delhi-based independent investment adviser. Your comments, questions and reactions to this column are welcome at ticker@livemint.com
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First Published: Mon, Jun 23 2008. 07 20 AM IST