The Eu(ro)phoria or Despair?
The market has erased most of the gains which it had made from the start of 2012. This was mainly weighed by the global sentiments and the domestic macro problems. The market mood on Europe has soured for 2 reasons: concern that Spain will have to recapitalize its bank and the political “circus" risk that has migrated from the periphery to the core.
The ultimate fate of the Europe is however is not only in the issue of Greece exit but will depend on whether the global growth can be sustained or not. Political commitment to euro area integration, which remains strong, can collapse if the economic crisis continues indefinitely. The Re-election in Greece would happen, on 17th June, so that the government can be formed. Therefore Greece issue is just a part of the whole crisis. Spain is the latest euro area country to be scrutinized by the markets, primarily because its banks still need to be recapitalized to the total of euro 125billion while its underlying economic fundamentals continue to deteriorate.
Also, the overall financial markets have been under a constraint because the situation right now is not only Greece exit but the whole euro zone v/s other emerging economies. This event is also throwing lights on various other economies which are coming under the scanner now. Specifically US, which was on a recovery pace will be hit with the euro zone crisis as well. The direct hit to growth will come through trade with U.S. exports to the European Union accounting for 19 percent of total exports, and those to the euro zone represent 13 percent of the total. Europe also is the biggest trading partner for China. China is also facing the issues of slowdown. Loss of this market would ripple slowdown worldwide.
For India Capital flows into the economy and exports are likely to take a beating. World still holds the US-$ as the majority of their foreign exchange reserves, the Euro is a close second (about 25% of holdings) Since the world reserve currency also acts as the international pricing currency for oil, gold, and other products traded on world markets, the decline of the value and the confidence in the Euro could have a devastating impact on all aspects of global trading including India.
Further, exchange rate depreciation would worsen the inflationary conditions in the economy. Therefore, the RBI would have to continue with its anti-inflationary stance in the near term if domestic conditions do not improve. Most of the rallies which we saw in past were more of a liquidity driven one, and other macro fundamental issues were ignored. Liquidity was seen through the QE1 and QE2 and the 2 LTRO’s which were released globally, this benefited most of the economies. As liquidity started drying up the rally fizzled out. So at present the global uncertainty and the sustainability issues of euro zone countries like Greece and drying up of liquidity is again putting pressure on most of the emerging economies.
The ripple effect
Considering the euro zone crisis, Greece crashes out of the euro. Yields will skyrocket for Spanish and Italian bonds locking them out of the government debt markets. Investors will withdraw cash in panic over the possibility of their countries leaving the euro zone, too. It will have a ripple effect on Global equity markets. Earlier investors piled into U.S. markets as a safe haven. But as euro started plunging the U.S. dollar started strengthening. The basket of currency Dollar index reached the levels of 83. European banks started facing funding shortages as investors shun the euro zone and the banking system seizes up. In all, global markets will become chaotic.
Till now we were experiencing a dollar carry trade scenario but since the dollar is becoming stronger against most of the currencies on the uncertainty and liquidity constraints this is further hurting rupee dollar equation for our economy. This is also impacting negatively our markets due to lack of foreign flows and weakening of the rupee. The problem with our economy apart from the global uncertainty is also country specific mainly because lack of policy actions by the government, fiscal situation is deteriorating, inflation concerns, slowing growth and higher interest rates is impacting the overall growth scenario for India.
The solution - globally
So what’s the solution, globally Euro bond would be one option to be looked in but again it needs approval from the Germany which is still a strong economy. Also for Greece to stay in the euro zone, the political parties which are ready for the austerity should be preferred in election. Right now what we can say is to just wait and watch the global events to unfold.
India – The lag effect
On domestic front we do feel that short term pain will continue for India till global events unfold and till any specific policy actions are taken by the government. But if we are to look at the long term perspective for India that is 1 year down the line then we feel among these worries, one thing that is positive is that crude has been falling due to slowing global demand which is proving beneficial for us as we are major importers of crude oil. This will help to cap the subsidy burden on the government. Most of the commodity prices have also corrected and this will help the Indian corporate to improve the cost efficiency by curtailing their input cost and improving their operating performance. Stabilizing of the rupee and lowering of fiscal deficit will further helped by curtailing of gold imports and crude imports at lower cost. Also with government policy action on cards will be sentiment booster for the sectors like infra, CG, auto and banking which have been the major draggers for the market. Going forward the investment cycle will also pick up which will further improve the situation. This is a vicious cycle which will impact but with a lag effect of almost 2-3 quarters. So we need to watch for next 2-3 quarters for a turnaround signals.
On a little longer term, 3-4 years down the line once this all picks up the mother of bull run will start for which we all are waiting for and that would come by 2016-2017 when Sensex can target 45000-50000 levels. So we can summarize as “short term pain but long term gain".
The author is Senior Vice President (Equity Research) at Anand Rathi Financial Services
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