Global risk appetite holds key

Global risk appetite holds key for Indian stocks which have corrected after hitting fresh 2-1/2-year highs recently. Abundant global liquidity has ensured that inflows into Indian stocks rise whenever investors globally are in risk taking mode. Capital inflows help India fund its current account deficit.



In fact, the India growth story looks all the more promising when capital inflows spike. Indian firms have raised large sums of money over the past 1-1/2 year or so, to fund expansion plans and or to reduce debt. Foreign institutional investors (FIIs) have pumped in a net Rs 59142 crore in calendar 2010 so far, as per data from the Securities & Exchange Board of India (Sebi). This includes inflow of Rs 20098.70 crore in the primary market and Rs 39043.30 crore into the secondary equity market. The primary market data includes funds raised by share sales to qualified institutional buyers and initial public offers etc.

The Indian market is among the most expensive markets in the world due to investors believing that India will deliver a decade of sustained 8-9% GDP growth.

According the Reserve Bank of India, a combination of strong growth outlook for India and the probability of monetary exit being delayed by the advanced economies, could lead to acceleration of capital inflows, which will have to be managed, as in the past.

On the flip side, in the event of a global risk aversion caused by fears of a double-dip US recession or for that matter any other reason, FIIs may dump Indian stocks. The selling could be aggravated by redemption pressure at their home countries -- the US or Europe.

Domestic risk capital allocation behaviour also tends to be highly correlated to global markets. It may be recalled that during the global credit crisis in 2008-2009, the domestic financial system also suffered from risk aversion. Cost of capital spiked up and capital market funding almost came to grinding halt. Companies, particularly small and medium scale entities, with good business fundamentals suddenly lost access to capital, turning them into non-performing borrowers in the banking system.

If capital inflows slow down significantly or turn into outflows, the rupee could depreciate significantly and domestic liquidity environment will tighten. While the Reserve Bank of India (RBI) does respond with measures to offset decline in forex reserves by injecting liquidity, its response, by its very nature, has to be reactive with some damage to financial market confidence being inevitable.

The duration of global financial market risk aversion affecting capital inflow trend is important. If the risk aversion in global financial markets is for a short period of time, capital inflows to India will resume once risk appetite returns.

The fundamentals of the Indian economy remain strong, with resilient domestic demand.

Investors are keenly watching data on sowing for the kharif harvest. Overall, nearly 90% of the total normal kharif acreage was seeded till 20 August 2010 and the standing crops are reportedly in good shape. The southwest monsoon rains were 29% above normal in the week to 25 August 2010. There were good showers over Bihar, Jharkhand and West Bengal, where the seasonal rains were scanty until last week. This will help farmers in these areas grow coarse cereals, pulses and fodder.

The cumulative rainfall during the period from 1 June 2010 to 25 August 2010 was 2% below normal. Rainfall over the country as a whole for the second half (August to September) of the 2010 southwest monsoon season is likely to be normal, according to the India Meteorological Department (IMD). Quantitatively, rainfall for the country as a whole during the period August-September 2010 is likely to be 107% of long period average (LPA) with a model error of plus/minus 7%, according to the weather office.

The revival in monsoon rains has raised water level in reservoirs to 55% of capacity, up 6 percentage points in the past week. More water in reservoirs will boost the supply of hydropower, which shares for a quarter of India's total generation capacity, and help irrigate crops even after the monsoon season.

The south west monsoon is important for India as about 60% of the country's farmlands are rain-fed and more than half of the workforce is employed in the agriculture sector. The weather office expects this year's monsoon rains to be at 102% of the long-period average. If the southwest monsoon for the June-September monsoon season turns out good and if it is well distributed, it will help raise farm output, boost rural incomes and lower food inflation.

The headline inflation eased in July 2010, fuelling expectations that the central bank may lessen the scale and pace of increase in interest rates. The Reserve Bank of India will undertake a mid-quarter monetary policy review on 16 September 2010, as per schedule. Finance Minister Pranab Mukherjee said this month rising prices were a cost of rapid economic growth.

Auto and cement stocks will be in focus next week as companies from these two sector start announcing sales volumes for August 2010, from Wednesday, 1 September 2010.

On the macro front, the government will unveil data on GDP growth for Q1 June 2010 on Tuesday, 31 August 2010. The economy expanded an annual 8.6% in Q4 March 2010.

HSBC's manufacturing Purchasing Manager's Index (PMI) for August 2010 will be out on Wednesday, 1 September 2010. The manufacturing PMI had edged up to 57.6 in July 2010 from 57.3 in June 2010, when it slipped from a multi-year high.

HSBC will also, later, unveil the services sector PMI for August 2010. The index, which shows business activity in the services sector, had eased to 61.7 in July 2010 from 64 in June 2010.