Now that the price of oil is going back to the $100 (Rs4,430) a barrel mark, the Indian equity market has staged a nice rally. After all, the Indian economy will be one of the biggest beneficiaries of lower oil and commodity prices. Moreover, our stock market was one of the biggest losers when oil prices were rising. So why shouldn’t it be a big gainer now?
Well, actually India has been one of the better-performing markets last month, easily outperforming most other emerging market indices. Still, that’s not very comforting when the market is down more than 30% from its highs. Most experts are cautious and nobody is predicting a runaway rally.
One reason is that the domestic economy is slowing down. The interest rate hikes work with a lag, which means the worst of the slowdown is still ahead of us. More important, perhaps, is the lack of interest on the part of foreign institutional investors (FIIs). Although FIIs are now less underweight on India than they used to be, a Citigroup report points out: “Outflows of $810 million from offshore Asian funds in the last two weeks have offset half of the new money that taken in July.” As a result, total net redemptions have risen to $13.7 billion year-to-date compared with $16.4 billion of net inflows in 2007, it says.
Further, redemptions from global emerging market funds totalled $2.5 billion in August, “four times bigger than outflows from Asian funds…likewise for global equity funds which faced outflows of $2.4 billion in August. This gives little hope that global money could provide support to Asian equities in the current downturn,” the report said.
As the credit crisis continues in the West and foreign investors continue to sell in our markets, more and more voices are coming round to the conclusion that the runaway boom in stock prices during 2003-07 was based on an unsustainable combination of factors and that, even after the current crisis ends, the world will not be the same again.
Marc Faber, who had forecast a bust in Asia before the region’s financial crisis in 1997, has long held this view and it’s no surprise that he has been recently reiterating it in a note to his clients. Says Faber, “I have a friend who is an outstanding economist who thinks that the Asian current account surpluses will shrink in 2009 by about 50% from their peak in 2007. In this scenario, global liquidity would become extremely tight and would have a devastating impact on asset markets including real estate, commodities, non-AAA bonds and equities.”
The root of all this is of course the credit crunch, which has resulted in a wave of de-leveraging. That’s because the big international banks, which were the source of much of the funding for the hedge funds and other traders, have been badly hit by the credit crunch and are desperate to raise capital to fill up the holes in their balance sheets. As a result, as a recent survey by the US Federal Reserve found, banks had tightened lending standards, not just for mortgages but also for consumer loans, credit cards as well as for commercial and industrial loans. Add to that the demise of large sections of the over-the-counter markets for credit derivatives and the upshot of all this can be summed up in one word: de-leveraging.
Faber argues that lower levels of lending will lead to a cutback in consumer spending in the US, which will lead to lower consumption growth and fewer imports. Together with slowing growth in Europe and Japan, this will mean lower export surpluses for the Asian nations. Also, the impact of de-leveraging is not just on the “fundamentals”—global liquidity will also be severely affected and stock markets will no longer get access to the easy money that had taken them to all-time highs a few months ago.
A Citigroup global equity research report, however, points to a source of fresh liquidity. According to the report, “Most financial assets look cheap when your source of capital is oil at over $100 a barrel. This is the new big arbitrage trade. Move over private equity, here come the oil-financed sovereign wealth funds. The figures are mind-boggling—at current prices, total world oil reserves ($135 trillion) could buy the S&P 500 index 11 times over. Just one year of production ($3.3 trillion) would buy the whole MSCI Emerging Market index.” Simply put, the Citigroup strategists believe that oil-rich investors should invest a part of their proceeds in equities.
Also, China may not be so badly hit. The Chinese government is already taking steps to support growth—a JPMorgan note last week said the government there is considering a fiscal stimulus and an easing of monetary tightening, which sent the Chinese market up sharply. In other words, the hope is that China will remain a source of liquidity, as will the oil-exporting nations. That should ensure that the worst of Faber’s doom-laden prophecies fail to come true.
The Indian market, however, may not gain much from that hope. That’s because the oil-exporters’ fountain of liquidity depends upon the high price of oil. And, if China spends a lot on infrastructure to keep its growth high, then that too will be good for oil prices and for commodities. For India, dependent on imported oil and commodities, that is not good news. In short, if Faber’s scenario works out to perfection and global liquidity collapses, then India, along with all other markets, will be badly hurt. If oil and commodity prices stay high, that may provide liquidity to oil and commodity producers, but it’s unlikely that will help India.
To read all of Manas Chakravarty’s earlier columns, go to www.livemint.com/capitalaccount
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org