Fall in commodities to keep equities under strain: Experts

Last two weeks have been eventful for global investors and for the Indian economy. Globally, gold got cheaper by 17 percent in just two weeks, crude was down 12 percent. For India, cheaper gold and oil makes the monstrous current account deficit (CAD) look more manageable and also cuts the fiscal deficit.

Also Read: CRISIL sees FY14 current account deficit at 4.5% of GDP

There was additional good news for the Indian economy as exports went up 7 percent in March after falling for several months and inflation fell below 6 percent for the first time in 40 months. However, Pronab Sen, former chief statistician feels international drop in gold price may stimulate people to buy more and that would not be very good given India's high current account deficit (CAD). Meanwhile, Bharat Iyer, head - Research, JPMorgan agrees that correction in global commodity prices will be positive for the economy. However, if this fall in commodity prices presages risk-off situation, then one should not be surprised to see Indian equities correct in sympathy, he cautioned. Below is the verbatim transcript of the discussion on CNBC-TV18 Q: March trade deficit has fallen to USD 10 billion from USD 20 billion in each month from October to January- now can the Reserve Bank of India (RBI) proceed as if the current account deficit isn’t a huge problem? Sen: No quite. The issue here is that we had two very positive things happening because of global developments; drop in the price of oil to sub USD 100 per barrel and a sharp drop in price of gold. Repercussions on the Indian economy aren’t that obvious. As far as oil is concerned, sure it is a plus-plus. It is good for us provided it stays that way because every dollar drop in oil prices drops our CAD by Rs 1000 crore which is good. But how long is it going to stay? We had bad news coming out of Europe, so, there are some negative sentiment operating on this that can turn around. But as long as oil does not go up very sharply, again it is a good thing to happen. In case of gold, we have to be a lot more careful because under normal circumstances where people are trading in gold, this would have been a great sign because it has signaled that people should actually stop buying and holding gold. But in India, people don’t sell gold at all – once they buy it, they tend to hold on to it unless there is a calamity. The international drop in the price of gold may stimulate people to buy more and that would not be very good. We are not going to know that until next month. Q: Let me look at the same problem from a fund flows angle. A risk-off sentiment and maybe fears of low growth later in the year had led to a crash in commodity prices. But while this will help trim our CAD, do our problems go away since the risk-off will also mean foreign institutional investors (FII) flows into Indian equities could fall? Iyer: Over the near-term what may be good for the economy may not necessarily be good for the stock market and vice-versa. There is no denying the fact that the correction in global commodity prices that we have seen recently if sustain, will be positive for the economy. It bails us out of multiple problems- be it inflation, be it current account, be it the fiscal account. As far as equity markets are concerned, we await evidence on the nature of this correction because if this does tend to be a long drawn and more prolonged correction and if this signifies a risk-off, it could impact our equity markets as well. Over the last 14-15 months, we got USD 36 billion in equity investment flows and that is a disproportionate share of the portfolio that we got. Most emerging market (EM) analysts are very serious overweight on India at this point in time. If the correction in commodity prices presages risk-off situation then don’t be surprised to see Indian equities correct in sympathy. If these things sustain, then it is going to be good for the economy and down the line investments will come back. _PAGEBREAK_ Q: Lower trade deficit is largely a gift from global moves but inflation is our own achievement because of some lower fiscal profligacy and a tight monetary policy. Will this achievement of sub 6 percent inflation make India more attractive destination for funds? Iyer: We could be relative outperformers. It’s been a very good job on the part of the authorities be it the central bank or the government to get inflation under control. Foreign investors do view that very positively. Investors do invest in markets like India mainly for growth. It is very important that this correction in inflation sets the base for a very robust revival in growth and that is what foreign investors would be looking forward to. Q: How lasting is the victory over inflation? Consumer price index (CPI) is still 10 percent, but falling. Is it too early to celebrate? How you see inflation moving in the next 12 months? Sen: I think it is not too early to celebrate, because what you are seeing is that the two arms of inflation are operating differently. As far as producers are concerned, which is what wholesale prices are telling us, it is very clear inflation expectations have been broken. The company’s belief is that the pricing power has gone away from its hands. That is a good thing. So, the sub-6 percent Wholesale Price Index (WPI) growth is nothing to get excited about because what we have known already for the last month or two is that core inflation was down to sub-4 percent, now it is sub-3.5 percent. So, this good news has been around for a while. The rest of it is trailing that. The real question is CPI because that is what drives the expectations of households and the savings behaviour. My personal take is that there is roughly three-four months lag between the wholesale price index and the CPI. So, the CPI will trend down, but I am not confident that the inflationary expectations among the households has been broken. This means that purchase of gold continues to be a possibility and a threat to current account deficit position. Q: Let me come to you with the growth issue that you alluded to. How are you assessing growth? Is the worst over in terms of gross domestic product (GDP) or corporate earnings or will it become a little worse before it gets better? Does it improve sharply or will it linger at 5 percent GDP growth and maybe 7-8 percent earnings growth for a goodish bit, like several years? Iyer: I think the correction in global commodity prices, the easing of local inflation and the containment of the deficit are perhaps setting the pace for growth down the line. But that said, I am not in the camp that believes in a V-shaped recovery. I think recovery is going to be little more long drawn than that. So, if perhaps we end fiscal ’13 with GDP growth of around 5 percent, I believe that fiscal ’14 could be marginally better, somewhere in the region of 5.5 percent give or take 20 bps on either side. Likewise, in terms of the earnings trajectory, we probably end FY13 with earnings growth of 6-8 percent, and that perhaps improves to about 8-10 percent going into FY14 because a lot of the headwinds that we have seen are not going to dissipate overnight and while we have seen a lot of reform initiatives, a lot of initiatives take care of the muddle macro, those initiatives will take time. We just seeded those initiatives and for them to start playing out will perhaps take six-nine months. Q: How do you see growth hereon since the current account deficit, fiscal deficit, inflation all these monsters are looking much smaller than they did a quarter ago. Can Reserve Bank of India (RBI) get a little aggressive on rates? More importantly, how will growth shapeup, 5 percent we know in FY13. How much in FY14, how much in FY15? Sen: That is very difficult to say. I think you need to wait a little bit more. One of the reasons that will give you a low current account deficit is if the investment of the small and medium enterprises (SME) sector has dropped because what was happening until now is corporate investments are dropped, savings are dropped, but SME investment continue to stay up and that is what increase the CAD. When we are seeing the CAD contracting sharply, one of the causes could be that it is basically SMEs who have stopped investing in which case it is not good news at all because you are then not building up capacities for the future. I would at this point go with very guarded optimism. I would want to see at least the March Index of Industrial Production (IIP) figures. That is going to be little while from now.