Home / Opinion / Stability and challenges await in 2014

As we draw close to the end of 2013, the global economy and the financial markets are possibly in the best shape since the beginning of the financial crisis in 2008. The US economy is growing at a healthy pace, though it’s expected to moderate from the current level. The economic activity in the US grew 4.1% in the third quarter of the calendar year. The unemployment rate is 7%—though still high, it’s the lowest during the post-crisis years, and is expected to improve further in the coming months.

Europe is not progressing as desired, but no one is talking about a euro zone break-up or collapse of the euro any more. Numbers coming from Japan have improved in the past one year, and it looks like a hard landing has been avoided in China, at least for now.

However, the most important development from the markets point of view in 2013 was the US Federal Reserve’s announcement that it will cut back its much talked about quantitative easing programme by $10 billion per month from January 2014. The Federal Reserve will now be buying $75 billion worth of assets from the marketplace. “In light of the cumulative progress toward maximum employment and the improvement in the outlook for labour market conditions, the Committee (Federal Open Market Committee) decided to modestly reduce the pace of its asset purchases," the US central bank said in its statement on 18 December.

The announcement was well accepted by the financial markets and stock prices went up. This is in contrast to the huge volatility that asset prices witnessed all over the world when the Federal Reserve had indicated a tapering of its bond buying programme for the first time during the summer. This time around, the market responded positively because it was prepared for such an outcome, and the quantity of reduction in asset purchase was modest.

Therefore, overall, even as some economists are worried about low inflation in the developed world and are warning against deflation, the global macroeconomic set-up looks more comforting than anytime in the past few years. This is not to suggest that the global economy will remain problem-free in 2014, but the pain has subsided a great deal for sure.

However, the same cannot be said about India. The year 2013 was yet another difficult one for the economy and the markets here. Although the stock market is showing a year-to-date gain of about 7%, it was subjected to a fair amount of volatility during the year. A number of issues affected expectations and outcomes in the financial market—high inflation, higher nominal interest rates, lower economic growth, subdued earnings, political developments, and the tapering by the Federal Reserve.

Although Indian markets now have clarity on the issue of tapering, all the other concerns will be rolled over to 2014. After a long time, the markets in India are likely to be driven more by how things take shape internally rather than by external factors as has been the case in the past few years.

From a pure economic standpoint in India, the most critical issue will be the trajectory of inflation. The consumer price inflation, which is being seen as the new normal anchor for the Reserve Bank of India (RBI), continues to remain above comfort level (it was in excess of 11% for November). Till the level of inflation comes down, interest rates will remain elevated and growth is unlikely to pick up in a meaningful way.

The second quarter gross domestic product growth at 4.8% was marginally better than the first quarter’s because of the boost from the agricultural sector and exports. But neither of these two can be seen as a credible sign of economic revival. Further, the government is reported to have met 84% of its deficit target by the end of October. A cut in spending to meet the full-year deficit target is likely to affect growth prospects.

However, the biggest event of 2014 for the markets will be the general elections. Interestingly, markets celebrated Bharatiya Janata Party’s victory in the recently concluded assembly elections. But the gains were quickly overtaken by hard economic reality. Don’t be surprised to see a similar outcome after the general elections even if what is seen as a favourable formation is voted into office.

The new government will have the challenging task of bringing down deficit, containing prices and rebooting investments. Till these indicators are brought under control, any meaningful recovery in the economic activity will be difficult to come by. But if we get a hung Parliament in 2014, there will be trouble for the economy and the financial markets.

End Note: The markets saw many twists and turns in 2013. At one point it looked like things were going out of hand on the currency front, but RBI’s intervention and course correction by the US Federal Reserve saved the day. Now that things in the external environment have stabilized a great deal, the focus will return to domestic dynamics. While expectations in the market are likely to be shaped by political developments, at least in the first half of 2014, investors will do well to not lose sight of economic indicators.

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