Looking for right impetus - Money & You (The Sunday ET)

Morgan Stanley Asset Management recently highlighted interesting facts about Brazil and Turkey’s economic growth during the past few years. For much of the past decade, the emerging markets of Brazil and Turkey were considered identical twins.

Following their long history of high indebtedness and hyperinflation, which led them to the edge of the abyss in 2002, both economies embarked on a path of structural reforms and staged remarkable recoveries. They appeared to share a common destiny, with their stock markets and currencies trading in sync.

Till oil did them part. The commodity price explosion led by oil since late 2007 separated the fate of resource-rich Brazil, and resource-poor Turkey. Their divergent paths are symptomatic of the way the world has been operating this year. The only axis around which the global economy revolves is oil. In the first half of 2008, stock markets of most oil-exporting countries soared to new highs, while those of oil importers plunged 15% on average.

One, however, needs to notice the remarkable efficiency with which Brazil’s economic administration has handled the current scenario. Brazil pre-empted the global food and energy spike by raising the benchmark lending rate three times this year to 13%, one of the highest in the world. Caging the inflation threat has also won Brazil a new standing in the financial markets.

It is also interesting to note that in spite of such a sharp currency appreciation, Brazil is the world’s leading exporter not just of coffee but soybeans, beef, sugar cane, ethanol and frozen chicken. In India, we are scared of currency appreciation as we feel exports will get hurt!

But oil could sow the seeds of its own destruction. The oil price surge is causing widespread inflation problems, even in oil-exporting countries. It’s telling that the markets of Brazil and Russia have over the past several days joined the global bear run.

In the United States, shares of energy companies are declining despite forecasts of ever-rising oil prices. But today’s global economic structure doesn’t allow the stagflationary impulses of the 1970s to build for long. To put the current situation in a long-term perspective, average inflation in emerging markets is currently running at 8%, up from a record low of 4% in 2005 but still well below the 20-30% levels of the 1970s and 80s.

The main risk to the world economy in the months ahead is a substantial slowdown in global growth rather than any further significant rise in price pressures. The Indian capital markets displayed a sharp volatile trend with a negative bias after the RBI credit policy was announced last week.

The RBI has further cautioned that economic growth is likely to moderate further in FY09 (has revised GDP growth target down for FY09 from 8.5% to 8%) and most interest sensitive sectors such as auto, real estate, construction are likely to take a hit on the profitability front in the coming quarters.

Most banks have already reacted to the latest RBI move by raising their prime lending rates by around 50-75 bps which is bound to make home, personal and auto loans far more expensive. Importantly, it seems the RBI will continue to have a hawkish view on inflation, which could see GDP growth moderating further, with both consumption and investment growth showing further decline.

Nevertheless, some key positives during last week were the continued softening in crude oil prices, now ranging around $123-124 barrel, which now clearly looks set for a further downtrend amidst reports that US oil consumption has recently shown a negative growth.

Also, headline inflation numbers have continued to rise to 11.98% week on week but the pace of growth has slowed down which is comforting. However, despite all the fiscal measures taken by the RBI, inflation still continues to remain high and is unlikely to ease-off soon. RBI is targeting to bring down inflation from the current level of 11-12% to about 7% by March ’09, with long-term inflation target pegged at 5%.

Going ahead, the markets are expected to hold the recent lows , although there could be further global shocks since most of the negatives in the domestic arena have been fully discounted in market prices. Also, the recent F&O data suggests that the August ’08 series is starting on a lighter note which is the lowest since December ’07 series.

This leaves less room for any further downside. The recent lows on Nifty of 3,800 is likely to hold the for near term and in the short term, the markets may see further extension of gains. Any positive move from the government on PSU disinvestment or FDI liberalisation may provide the market with necessary impetus for a rally.

(The writer is CEO, Reliance Money ,