Markets following the 1990’s pattern is positive
The current state of the market and the economy reminds one of the 1990’s. India had problems of inflation and bad loans. Twelve years later India has the same problems of inflation and bad loans. India came out of 1990’s stronger due to forced reforms, can it come out of this current mess? Table 1 shows the movement of markets along with levels of inflation and NPA’s (Non Performing Assets) in late 1990’s.
Banks in India in the 1990’s were facing write downs on loans given to sectors such as Steel, Textiles, Power and Cement and bad loans were a huge issue. The government had to recapitalise banks and protect institutions such as ICICI and IDBI from going under. The government at present has to recapitalise banks as loans given to power, construction, airline and other sectors are going bad. SBI, the country’s largest lender had net NPA’s of 2.04% as of second quarter 2011-12 against net NPA of 1.7% seen a year ago.
Inflation at 9.7% is way beyond RBI’s comfort zone, though RBI has forecast that inflation will come off to 7% end March 2012. Inflation in the beginning of the 1990’s was consistently over 10% and interest rates were high on the back of high inflation. Ten year government bond yields were above 10% in the late 1990’s, even though inflation had started to trend down in the second half of 1990’s. Ten year GOI yields at present is trading at multi year highs of close to 9%.
On the global front, the 1990’s saw the burst of the Asian tiger economies bubble while it is the turn of the developed economies to face the burden of debt at present. Global markets are in a huge turmoil on the back of debt issues of Greece and Italy. Italian bond yields have touch unsustainable levels of 7% given its total debt at USD 2.2 trillion or 120% of GDP. Markets are worried about the unsustainability of debt levels in European countries leading to a sell off in equities and currencies. European equity indices are down by over 12% since August 2011 while the Euro has fallen by over 5% against the US Dollar on the back of the sovereign debt issues.
How will markets behave going forward?
The problems facing the economy and markets will not go away in a hurry. It is a slow process as government’s cut down deficit and central banks fight inflationary pressures. The bright spot is that markets are forcing the government to do the right things. Eurozone governments are in austerity drives while the Indian government is fighting to keep its deficit down. The RBI is focused on keeping inflation under control while lenders are becoming risk averse and are focusing on strengthening balance sheets.
The effect of fighting turmoil tells on growth. The Eurozone is likely to face a recession in 2012 while India’s GDP growth is forecast to drop by 1% in 2011-12. Indian is also facing pressures on its currency due to its current account deficit, which could cross 3% of GDP this year on a widening trade gap. October 2011 trade deficit at USD 19.6 billion was a record high leading to worries on the current account.
Markets will be volatile in the short term, but as the dust settles and effects of right policies tell on the economy, markets will look to factor in a stronger period of growth. This process could take at least six months and until then it will be a tough time for investors.