Devangshu Datta: Attention focused on Greece and China

Indian markets could continue to be dominated by external considerations as the possibility of Grexit looms large and China's equity markets see sharp corrections

Trading this week in Indian markets could continue to be dominated by external considerations. It could be a low news week in domestic terms, which means that attention will inevitably be focused on Greece, and perhaps on China. Terrorist strikes in several locations by ISIS could also affect sentiment adversely.

Greece is a tiny nation which contributes about two per cent of the gross domestic product (GDP) of the euro zone. However, it has caused far more than its fair share of chaos. For several years, it has been a toss- up, whether the Greeks can repay or service outstanding debt and reduce its public debt to GDP ratio.

Speculation about a Greek exit from the currency union - the so-called Grexit - has periodically spooked global financial markets. Talks continued last weekend at the time of writing, with the Greeks trying to cobble together a reforms package, which will induce their creditors (mainly in Germany) to give them more time to service debt.

If a deal goes through, it will probably mean hardening of the euro and a bounce across risky assets such as global equities. If the talks collapse, the probability of a Grexit would loom larger with chances of the euro being hammered and perhaps, a retreat by portfolio investors to the safe haven of US treasury debt. There is reason to believe that the Greek economy cannot carry out the structural changes it requires while retaining the Euro because a drastic currency devaluation is required. So, a deal that staves off Grexit will mean trouble down the line anyway.

China's equity markets saw sharp corrections in the past fortnight. The Shanghai Composite Index is down 19 per cent in the past 10 sessions. The tech-specific ChiNext index was down 28 per cent and every industrial sector lost ground.

There has been talk of bubbles building up across Chinese equity and real estate. The stock market index had gained over 100 per cent in the past year and the median valuations of all listed companies was above PE 55. Maybe an asset price deflation has started, given slowing growth and massive initial public offerings (IPOs). If Chinese stocks continue to retreat, it could cause contagion with investors pulling out of emerging markets.

One of the reasons for Chinese slowdown has been an inability to maintain exports, given a generally slow global economy. India's trade data shows an exaggerated version of the same problem. Indian exports have declined in eight of the last nine months. Does this indicate a possible compression in global trade itself?

Raghuram Rajan is worried about that possibility. The Reserve Bank of India (RBI) Governor went public with those worries in a recent speech where he said central banks need to review the rules of the game. Otherwise, competitive devaluation strategies could lead to a situation where global trade stagnated, or contracted, as in the era of the Great Depression.

Given his track record, Rajan will be taken seriously, though it is hard to see how central banks might change tack now. The US Federal Reserve will probably raise rates soon enough but the European Central Bank and the Bank of Japan are continuing with quantitative expansions.

At "home", there are hopes that RBI might cut rates again, if the monsoon is better than expected. Early monsoon signs seem to suggest that rainfall will not be as deficient as the India Meteorological Department predicted. On the political front, Lalitgate promises much more entertainment and it could, given cricket's popularity, entangle more politicians across more parties. If it is still trending news in August, the Monsoon Session of Parliament could be affected.

Technically speaking, Indian equities have seen a sharp recovery in the past week, bouncing from the depths of Nifty 7950. The Nifty and Sensex pricelines have pulled up to around the levels of their respective 200 Day Moving Averages. It remains to be seen whether this recovery can be sustained. Any upside from here would require a change in mindset from the foreign portfolio investors (FPIs), who were net sellers in June. FPI decisions are once again, likely to be affected by events in Greece and China.