Devangshu Datta: Trundling along without much progress

Global traders suffered self-inflicted shocks through much of last fortnight as they sought news triggers in the absence of pointed news flow. First, markets twitched on rumours of another nuclear test by the Democratic People's Republic of Korea, as the nation in the northern part of that peninsula misleadingly labels itself. That fear was supplanted by panic at the thought that the Federal Reserve would choose to hike USD policy. In the meantime, China delivered better economic numbers and India delivered worse.

In all, it turned out to be business as usual through yet another fortnight. Weak American data on the service sector Purchasing Managers' Index, on retail sales, industrial output, and employment, make it unlikely that the Fed will hike the funds rate in the coming week. The European Central Bank has also maintained policy status quo.

China's industrial production in August topped market projections and private sector investment has stopped declining. If China does bounce, it would be taken as a lead indicator for global trade recovery. However, in a contra-indication, the International Energy Agency and the Organization of Petroleum Exporting Countries agreed that global gross domestic product (GDP) would remain in first gear, and crude prices would stay low. Crude slid by three per cent after that prognosis.

Low global trade and India's inability to increase its share of global trade are hurting. The Reserve Bank of India (RBI) Annual Report refers, inter alia, to the need for "a sustained revival in exports" to lead an acceleration in GDP growth rates. In reality, policymakers must hope for further export contraction! Exports have fallen in USD terms for the past seven quarters. The latest data shows cumulative exports for April-August 2016 were at $108.5 billion (Rs 7. 27 lakh crore) as against $111.9 billion (Rs 7.14 lakh crore) in April-August 2015.

The gloomy export data chimes with gloomy import data. Imports have dropped by 15.9 per cent in USD terms to $143.2 billion (Rs 9.6 lakh crore) for April-August 2016 from $170 billion (Rs 10.9 lakh crore). Even allowing for drops in petroleum prices and in official gold imports (more gold is being smuggled to avoid paying higher import duty), the imports sag suggests low demand.

That impression of weak demand is reinforced by latest inflation and manufacturing data. The Index of Industrial Production (IIP) contracted by 2.4 per cent year-on-year for July 2016. Cumulatively, April-July 2016 has seen 0.2 per cent expansion compared to April-July 2015. The Consumer Price Index (CPI) for August was running at 5.05 per cent higher than August 2015, on a year-on-year basis. This was considerably better than the 6.07 per cent year-on-year recording of CPI in July. Essentially, food inflation has come down.

Will these data (poor exports, lower CPI, low IIP) induce a policy rate cut from the RBI in October? Market consensus says no. The RBI will want to wait until it finishes the FCNR (B) swap reversal over the next three months, and/or the Fed does something to USD rates. However, the newly installed Monetary Policy Committee (MPC) mechanism allows for stronger transmission of government pressures for policy rate cut and it remains to be seen if the new RBI governor can withstand such pressures.

The economy just seems to be trundling along, without appreciable acceleration. Under the circumstances, Nitin Gadkari confessed that the "acche din" slogan of 2014 is turning into a millstone around the government's neck. The Bharatiya Janata Party has reached the halfway stage of this term, and there are multiple sarcastic references to that slogan given that the Q1, 2016-17 GDP and GVA (gross value added) estimates remain in the same zone as the 2015-16 estimates.

The stock market is now seriously overvalued. The Nifty, which tracks the 50 largest companies, is at a high price earnings (PE) ratio of 24-plus, and the broader Nifty 500, which tracks the 500 largest listed companies is at an all time high valuation of PE 28-plus.

Neither index has ever delivered positive long-term returns to entrants at such high valuation levels. Nor is there a signal of strong earnings growth. The Nifty 50 saw profits decline in Q1 (the financial sector was a culprit) and the very broad Nifty 500 also saw earnings contract in the past four quarters. Inflows have been driven by foreign portfolio investors (FPI) who are also betting on rupee rate cuts, going by their large-scale buying of rupee debt alongside equity.

A "jumla" about the commerce ministry pitching for rupee devaluation led to recent currency volatility. The minister had to issue a denial but currency movements remained volatile and rupee churn will continue to be minutely observed until the FNCR swaps are reversed. The RBI's 36-currency Real Effective Exchange Rate suggests that the rupee is substantially overvalued. But while a lower rupee may be useful for trade, a sudden drop could cause panic.

Technically speaking, the Nifty swung to a new 52-week high of 8,968 on September 7, and then corrected to 8,690 on September 14 due to fears of Fed action. There was heavy selling again from the 8,850 levels on Friday (September 16). Bulls will be hoping for higher highs (above 8,970) while bears look for lower lows (below 8,690). If the Fed does nothing, another upmove looks more likely.


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