US, China, Greece, Italy, Portugal and other Eurozone countries are all contributing to market sentiments at present. Domestic investors in equities have already been affected by domestic issues such as spectrum allocation scams, inflation and rising interest rates and are now forced to contend with global issues as well. Domestic and global headwinds are increasing nervousness amongst investors.
In order to overcome market fears, investors have to understand the causes and effects of global macro on Indian markets. It is true that global macro drives market sentiments in India, due to the large FII presence. FII’s have cumulatively invested around Rs 4.4 lakh crores in the Indian equity market, which constitutes around 20% of the free float market capitalization of the equity market. Hence, reading into and deciphering global macro issues becomes important.
The current global macro issues are a) China inflation and China local government debt b) Indebtedness in a few Eurozone countries and c) US unemployment and US debt issues. Taking each issue one by turn.
China inflation and China local government debt: China raised benchmark interest rates for the third time this year. The People’s Bank of China raised one year deposit rates from 3.25% to 3.5% on the 6th of July. China raised rates to counteract inflation, came in at 6.4% for June 2011 against 5.5% for May 2011. Inflation is running at a three year high and the government is worried about the effects of inflation on its large population. The rate hike comes at a time when there are concerns over Chinese banks exposure to local government debt. China’s local government debt was placed at USD 1.7 trillion, while Moody’s estimates that it is higher by USD 540 billion. Default by local governments on their debt will place China’s banks in trouble. Worries on local government debt will bring down investment activity in China leading to slower investment led growth. Investment spending contributes to almost 50% of China’s GDP.
China’s growth slowdown is a positive and negative for the Indian economy. On one hand, commodity prices come off, as China is the largest buyer of commodities in the world. On the other hand, global growth suffers, as China is the largest trading partner of many countries including Japan. China can also flood the global market with cheap goods due to the excess capacity it has. Inflation will come off due to a slowdown in China’s growth and this is good for the economy.
Indebtedness in Eurozone countries: A few Euro zone countries such as Greece, Portugal, Ireland, Spain, Italy and Belgium are all running large debt to GDP ratio. The gross debt to GDP ratio ranges from 140% for Greece to 92% for Italy. All these countries belong to the Eurozone and the debt is denominated in Euro’s. The holders of these countries debt are predominantly European banks, pension and trust funds. Given that these countries run large sovereign debt, and these countries are facing sharp drop in economic growth due to the inability of governments to spend, there is a serious issue of default by the countries on their debt. Since the debt is denominated in Euro’s, government’s cannot print money to pay back debt holders. Debt defaults will force European banks to make provisions on their investments, leading to sharp fall in valuations of these banks.
India is relatively safe from Eurozone debt issues as a) India’s debt is denominated in Indian Rupees and the government can print money to pay back debt holders b) India’s debt (center plus states) to GDP ratio is around 73% (2010-11) and the country is growing at a nominal rate (real GDP growth plus inflation) of around 14% and servicing the debt is currently not an issue. Indian banks do not have exposure to European government debt and banks are safe from defaults. Indian will not be directly affected by debt defaults by Eurozone countries but sentiments and global investor risk appetite will affect Indian markets.
US unemployment and US debt issues: US unemployment rate came in at 9.2% for June 2011, the high for this calendar year. The rate has actually fallen from close to 10% levels seen fifteen months ago but is still considered negative by policy markers in the US. High unemployment and sluggish jobs growth (18,000 jobs added in June the slowest in eight months) portends an economy that will grow at a slow pace. The US has reached it optimum level of debt at USD 14.3 trillion, and has to increase the ceiling to pay back debt maturing in August. The debate on increasing the debt ceiling is going on. If the US increases debt ceiling with committed increase in revenues though spending cuts and tax hikes, it is not good for the US economy as the economy then will face a slowdown given its high unemployment levels.
Slow growth in the US economy will prompt the US Federal Reserve (Fed) to support the economy through ultra accommodative monetary policy. The Fed will embark on a third round of government bond purchase, which will infuse liquidity into the markets. Accommodative monetary policy by the Fed will benefit India as liquidity will flow into the country due to its higher growth rates. However, it can also be inflationary in nature.
Global macro is both positive and negative for India. If the domestic issues on scams, inflation and rate hikes are resolved sooner than later, Indian market can do well despite global issues.