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Fuelling the market rally

Fuelling the market rally
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First Published: Mon, Aug 25 2008. 11 07 PM IST
Updated: Mon, Aug 25 2008. 11 07 PM IST
There is little doubt that the Indian stock market is inversely correlated to international oil prices. During the sharp rally in oil prices earlier in the year, India’s equity market was one of the worst performers. Now that oil prices have eased, the Sensex has been doing much better than most other emerging markets.
The reason is obvious: As it imports 70% of its oil needs, India’s economy is one of the most exposed to oil prices. True, domestic oil prices are much lower than current international prices, but lower international oil prices mean lower subsidies, less pressure on the fiscal deficit, a lower amount to be issued by way of oil bonds and less borrowing by oil firms. No wonder the bond market, too, has rallied. The accompanying fall in commodity prices is being expected to lead to lower inflation in the future, thereby easing the pressure on the Reserve Bank of India (RBI) to raise interest rates further.
It’s true that lower oil and commodity prices make the Indian market more attractive. The Sensex’s outperforming other regional indices is proof. But it’s doubtful whether these lower prices are enough to ignite a sustainable rally. That’s because, in the first place, oil prices are lower because global economic growth is slowing. That will mean lower exports in the future. It can be argued that India is one of the few countries in the region where growth is driven by domestic demand and, therefore, the impact of a slowdown in the West will be lower. But this reasoning ignores the fact that inflation is already very high and the impact of monetary tightening by RBI will be felt 12-18 months down the line. It also ignores the cyclical downturn in the Indian economy, seen most clearly in slowing industrial production. It also disregards the gay abandon with which the government has been distributing fiscal sops. Allowances must also be made, for the fact that risk aversion continues to be high. Finally, we must also note that the Indian market continues to quote at a premium to the region.
In short, while hedge funds will treat India as an oil put irrespective of these other factor—for, they make their money on correlations between two asset classes—any rally based on oil prices alone will find itself capped very soon.
Is a rally based on oil prices sustainable? Write to us at views@livemint.com
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First Published: Mon, Aug 25 2008. 11 07 PM IST
More Topics: Ourviews | Oil prices | Commodity | Sensex | Subsidy |