Economic Roundup, August 10, 2018

Economic Environment

  • Kharif and monsoon

  • Trade war

  • Earnings

How are the Indian and global economic environments affecting the financial markets?

  • The monsoon is 10% below normal at the peak time for Kharif crop growth which is worrisome. As a result, the sowing of Kharif crops is lower exacerbating the already lower sowing because of surplus production in the previous season. It is yet to be seen what the government-offered minium support prices (MSP) will be and how lower production this season is going to affect food prices and hence inflation, affecting Reserve Bank of India (RBI) policy. The International Monetary Fund (IMF) has already suggested that India should raise interest rates gradually to prevent inflation from rising far from the RBI medium-term target of 4%.

  • Weakening Indian macros due to the high oil price, rising current account deficit (CAD), increased government spending before the 2019 general election on wages for government workers and health scheme for the poor, and rising interest rates in the U.S have triggered Foreign Portfolio Investors (FPIs) and Foreign Institutional Investors (FIIs) to leave India, pressuring the stock markets and the rupee only to be buttressed, on net, by higher domestic rupee inflows into the stock market. Embracing the weakening rupee to support Indian exporters does not fully offset the rising cost of imports. The RBI intervened in May 2018 by selling USD 12 billion to stem the fall of the rupee but this is a vicious circle because unless foreign flow of dollars is reversed through inward FPI, FII, and Foreign Direct Investment (FDI) flows, decreasing foreign exchange reserves including because of RBI sales of dollars will continue to pressure the rupee.

  • The escalating trade war between the US and China could be a benefit to India to export more to the US and to China. Indian exports to the US could rise because of the cheaper rupee and any negotiated settlement of trade issues between the US and India. Adjusting to the trade war, China is lowering tariffs on Indian goods and this could increase Indian exports to China for India to be able to compete on an even keel with other Asian exporters to China perhaps contributing to lowering the trade deficit India has with China.

  • The June 2018 corporate earnings season has been good for the Indian economy. Though Indian banks still have non-performing asset (NPA) issues, they have become more profitable (or significantly less negative) as a sector in the June 2018 quarter when compared to the March 2018 quarter, year-on-year. As a result, the stock markets have given a big boost to the banking sector. Also, overall, all sectors of the economy have performed better with a positive double digit percentage profit-after-tax (PAT) in the June 2018 quarter when compared to a year ago leading to bullishness in the equity markets because nearly more than 60% of the companies have shown a positive percentage increase year-on-year of PAT.

  • Watching Nifty50, there are some concerns that the index’s trailing P/E is unsustainably high around 28 because on the two previous occasions this happened Nifty50 fell close to 50%. However, it must be remembered that those two previous occasions were the bursting of the tech bubble in 2000 and the housing bubble in 2008 in the US. It is possible that, if the earnings growth of Nifty50 component stocks is not commensurate with the rise in the index, the index could correct by about 10% as it did in February 2018 but not beyond that because there are no compelling triggers for a bear market or a deeper downturn as in 2000 and 2008.

    What to expect from the markets next week?

Indian markets may vacillate but with low volatility between being bullish and flat next week as the earnings season comes to a close toward the end of this month. They are expected to continue to remain stable but react to the second quarter earnings reports against the backdrop of the oil price and the trade war. Oil price may continue to move in a range-bound manner between USD 65-80/barrel, falling due to the trade war concerns and rising due to market tightness amid global growth. The other commodity markets will move based on, among other factors, how the Chinese economy is adjusting to the trade war.

Leave a Reply

Your email address will not be published. Required fields are marked *

*