The Indian economy is presently facing multiple challenges. There are many negative factors polluting the current investment climate.
First, derailment in the management of the central government's public finances resulting in elevated fiscal deficit on a sustained basis due to the heavy subsidy burden, fiscal stimulus rolled out after the Lehman crisis and populist schemes directed towards rural India.
Second, compared to just one per cent in FY11, India’s current account deficit is likely to shoot up to 3.5 per cent both in FY12 as well as FY13. This, coupled with pressure on foreign inflows on capital account, will result in a net deficit in the balance of payments (BoP) account that was last seen in FY09 and before that in FY96.
Third, CPI continues to rule above the 8.5 per cent mark, stubbornly refusing to come down despite best efforts by the Reserve Bank of India (RBI), thus, seriously eroding the purchasing power and savings of Indians.
Fourth, broad money supply (M3) growth in India is subdued and has, in fact, fallen below the 15 per cent mark. This has been due to the conscious effort by RBI to run a tight monetary policy in order to get inflation under control as well as to ensure closure of bad businesses. Tight liquidity, coupled with higher cost of funding, are affecting credit growth and economic activity, thus, taking its toll on capital formation / corporate investment. RBI’s intervention in the forex market to stabilise the rupee is further adding to the liquidity crisis.
Fifth, depreciation of the rupee is further aggravating the crisis. Unlike China, accumulation of forex reserves in India during the last decade has been primarily due to capital account surplus and not any surplus in current account. This limits RBI’s capability in defending the rupee, as the forex reserves form a pool of borrowed capital and are consequently susceptible to withdrawal any time. Any effort by RBI to stem up the rupee will be futile due to the fact that when RBI sells dollars, it is in fact, buying the rupee, the supply of which is practically unlimited.
Sixth, crude oil prices have continued to remain above the comfort level of $100. Any spike in oil prices from the current levels will have a cascading effect on the fiscal deficit and current account deficit, result in imported inflation and amplify the pressure on exchange rates.
In view of the above, and no visible positive triggers in the short term, equity markets are likely to remain lacklustre and may witness a downside of around 10 per cent from current levels, as valuations at the long-term average P/E of 14x are not very demanding.
However, looking at the broader indices would be misleading as I believe this is going to be a stock pickers’ and sector pickers’ market. For instance, sectors that are structurally well placed, such as cement and auto have done well and will continue their upward trajectory over the medium to long term.
The author is chairman & MD, Motilal Oswal Securities
