Market may recover as oil drops

The market may edged higher as investors may resort to bargain hunting after steep losses in the past few days caused by concerns over high inflation and fears of a further rise in domestic interest rates. Asian markets were mostly in the green today. Key benchmark indices in Hong Kong, Japan, South Korea, Singapore and Taiwan were up by between 0.14% to 1%.

Oil fell sharply on Tuesday, 10 June 2008, after the US Federal Reserve signaled it was taking aim at inflation, triggering a rebound in the US dollar and a sell-off across commodities markets. Further pressure on prices came after two of the world's biggest energy forecasters lowered their outlook for global energy demand as high prices bite consumers, easing the effect of lackluster increases in world production. US crude dropped $3.04, or 2.26%, to settle at $131.31 a barrel, well below last Friday (6 June 2008)'s record near $140.

A surge in global commodity prices led by crude oil spooked stocks across the globe in the past few days. In India, foreign funds have pressed heavy sales. FIIs sold shares worth a net Rs 4326 crore in the first few days of this month, till 9 June 2008. They had dumped stocks worth a net Rs 5011.50 crore in May 2008. Their outflow in calendar 2008 reached Rs 19695.40 crore, till 9 June 2008. There has been heavy buying by domestic funds led by insurance firms in the past few days, but that has failed to stop the slide on the bourses.

Brokerage earnings downgrades of Indian firms/stock prices amid rising input and interest costs for India Inc, high inflation and drying up of global liquidity due to credit crisis remain major concern for the Indian stock market. If inflation remains high, the Reserve Bank of India (RBI) would be forced to hike repo rate – a move that could choke overall growth of the economy. The Indian industry and consumer have already been reeling under high interest rates over the past few months. A further hike in rates would raise interest costs of corporate India and hit bottomline.

After 10 days of debate, the Union government on Wednesday, 4 June 2008 agreed to raise retail petrol and diesel prices by about 10%, more than expected, to help curb losses at its state-owned refiners. A sharp fall in the rupee against the dollar in the past few days has heightened concerns about inflation. This is because the fall in rupee will raise cost of imports which in turn will result in further rise in inflation.

According to rating agency CRISIL, headline inflation is expected to increase by 95 basis points on account of direct and indirect effects of the fuel price hike. The indirect impact which will be felt over the course of the next few months, it states in a note.

India’s fiscal deficit is slated to rise in the current financial year on account of the hefty fuel and fertilizer subsidies, a big sixth pay commission recommended wage hike, a debt-waiver package to farmers announced in the Union Budget 2008-09 and the recent sharp cut in duties by the government on petroleum products to mitigate the impact of oil price rise on consumers. A rise in fiscal deficit means negative savings for the government. This will result in higher government borrowings which in turn will keep interest rates high.

A well distributed monsoon will bolster food production, helping douse inflation. Agricultural output in India depends on good rains. The Indian Meteorological Department (IMD)’s second monsoon forecast for the crucial annual south-west monsoon (June-September) due this months which may indicate spatial rainfall distribution in the main sowing month of July 2008, will be keenly watched by market men. The IMD has forecast the 2008 monsoon rains would be near-normal and 99% of the average between 1941 and 1990.

A section of the market is of the view that the central bank may only use the reserve requirement route to tame inflation, fearing any hike in rates would further hurt growth already seen moderating to a still strong 8%-8.5% this fiscal year from 9% in 2007/08. To rein in inflation, in its monetary policy review for 2008-09 on 29 April 2008, the RBI raised cash reserve ratio (CRR) by 25 basis points to 8.25% to suck out excess liquidity in the banking system. RBI often says pass-through of high global oil prices is incomplete in India, complicating policy making.

According to a latest monthly June 2008 strategy report by HSBC Global Research, a possibility of Left parties withdrawing support to the government at the centre over the fuel price hike issue, cannot be ruled out. In such an environment with prospects of mid-term polls, the stock market is likely to remain nervous, HSBC says. Parliamentary elections are due in India in May 2009. HSBC’s 2008 year-end (calendar year) target for Sensex is 17,500, compared to current Sensex level of 15,066.10.

Another near term trigger for the market will be corporate advance tax payments for the first installment which falls due on 15 June 2008. The income tax law requires a company to 15% the estimated tax liability for the year as advance tax in the first installment. The advance tax payment by the corporate sector will give a cue on Q1 June 2008 results.

The market will also be keeping a watch on the industrial production numbers for April 2008, which the government will unveil on Thursday, 12 June 2008, which will give a cue on the extent of slowdown in the Indian economy caused by high interest rates.

The BSE Sensex may fall to a 10-month low of around 13,000 points by end-2008, as the Reserve Bank of India may raise interest rates to check inflation due to record oil prices, Credit Suisse said on Monday, 9 June 2008. "The market is still not pricing in the much lower earnings growth being forecast by corporates and banks," Nilesh Jasani, head of research at the Indian unit of the Swiss bank told reporters at a briefing on Monday, 9 June 2008. Uncertainty ahead of national elections will also weigh on the minds of investors, Jasani said.