Red signals for the bulls

Indian markets face several headwinds

The law of gravity caught up with the stock market on Friday with the Sensex seeing its worst decline in 10 months. The fall was a culmination of several factors. For one, the fundamentals of the Indian economy are not in great shape and the gross domestic product growth rate has decelerated for five straight quarters and, crucially, fell below the six per cent mark in the June quarter. The government’s reported stimulus programme to boost growth is further raising doubts about the fiscal deficit going off track. Markets are also worried that global issues — such as the rise in interest rates after the US’s bond-buying programme, the strengthening dollar, and the falling commodity prices — may take the sheen off emerging markets including India. The North Korea situation is another factor adding uncertainty.

Till now, the markets were rallying on liquidity, hoping for a possible turnaround in corporate earnings. But the latter looks unlikely for the next few quarters. Economic growth in the September quarter is unlikely to impress due to the impact of the goods and services tax (GST). Meanwhile, the current account deficit has hit a four-year high, and exporters, who were struggling with an appreciating rupee, are now hamstrung due to a working capital shortage as they await GST refund. Moreover, the government systems and GST filing software are not working well. Industrial production continues to sputter, and both private sector capital expenditure and bank credit growth will start only after capacity utilisation improves. The Reserve Bank of India has cut interest rates by 200 basis points since 2015 but this has not helped the corporate sector much. The non-performing assets in the public sector banking system remain a problem that still eludes effective resolution.

Foreign investors, who have pressed sales in the first six months of the current financial year taking profits out, do not seem to have the confidence to invest fresh funds. Their net outflow of Rs 2,868 crore between April and September may not seem much, but their caution is evident. On the other hand, domestic retail investors have accepted equity mutual funds as a major part of their portfolio and wealth creation path with net inflows of Rs 20,000 crore in August alone. As a result, mutual funds have bought over Rs 66,000 crore of stocks in the market and, according to estimates, they have another Rs 50,000 crore in cash waiting to be invested at cheaper valuations.

Markets that are driven by liquidity always run the risk that the flow of money can reverse quickly if things start going wrong. While it may still be early to say the best days for equity are behind us over the medium term, the seeds of a correction seem to have been sown. The best-case scenario for stock market investors would be a small adjustment in prices for the short term till investors start finding value, and a time correction over the medium term as clarity over economic and earnings growth emerges. The saving grace is that the rupee depreciation is likely to be a saviour for struggling exporters, and could aid GDP growth.