Indian stock market in a pickle as foreign funds flee
Whatever happened to the Indian equity market?
Back in November, the Sensex squeezed past 21,000 for a day before starting a three month, 16% fall.
In the same time, the world's main indices, the FTSE Dow and Nikkei have all gained up to 7%, two of the remaining BRIC countries have fallen no more than 7%, and Russia's RTS Index has gained 26%.
Unsurprisingly foreign funds have been fleeing Indian equities in the last three months.
India is in a pickle and two reasons spring to mind - the stock market was heavily overvalued and the Central Bank has been raising interest rates.
At the end of the year the price of the average share on the Sensex was 23 times its earning power (ie its p/e ratio was 23 x). The Shanghai Index was 18 x, Brazil's Bovespa 14 x and Russia's just 9 x (the Dow's p/e was 13 x). That kind of valuation may be fine if future growth seems assured, but there are signs it may be falling off.
GDP in real terms expanded at an annual rate of 8.2% in the last quarter - slowing from the 8.9% rate recorded in April to June. Now, this isn't a serious problem and no one is suggesting that the Indian growth story is in serious trouble, but it may be more than just a blip.
Maya Bhandari, senior economist at Lombard Street Research, says that, on a seasonally adjusted basis, growth was pretty much flat. She adds: "I would expect another leg down in the market in the coming few months."
Food inflation has been entrenched for some time, which means the Reserve Bank started putting up interest rates a year ago and has since hiked them seven times.
"In the last 25 months or so, we have had negative real interest rates and the central bank is going to have its work cut out to bring down inflation. And while it may be raising rates, the bank is holding more auctions and lowering the statutory liquidity levels for banks - all of which has inflationary consequences," says Ms Bhandari.
On top of domestic inflation pressures, the Middle East and North Africa crisis sent oil prices belting up above $100 a barrel, adding to the central bank's imperative to keep the upward pressure on rates.
India is the world's the fourth largest oil importer and imports over 70% of its oil requirements. Oil prices, which will stay high for as long as the Arab crisis lasts, will damage India's economy more than most of its main rivals. At the moment, most economists are pencilling in another half to one percentage point rise in rates.
Oil is also going to hurt government finances. In his March budget, Finance Minister Pranab Mukherjee estimated that the deficit would fall from an estimated 5.1% of GDP in the year ending March 31, to 4.6% next fiscal year.
But if oil prices keep on going up, the government will have to decide whether to keep on paying out fuel subsidies or deregulate diesel prices.
Keeping the deficit under control would suggest the latter.
Five state elections in the next few months would suggest the former.
London-based India investment consultancy director Deepak Lalwani points out that foreign confidence in India has also not been helped by a slew of scandals, the biggest being allegations that the 2008 sale of second-generation, or 2G, cellular licenses resulted in losses of nearly $36bn in potential revenue for the government.
But, he says: "All the local businessmen will tell you India continues to grow despite all the problems with the government. That is the strength of the India growth story."
The government is trying, somewhat half-heartedly, to be proactive.
The budget did make some gestures towards reform, increasing the cap on the amount of money Indian companies can borrow offshore and allowing foreign retail investors to buy into domestic mutual funds.
Mr Mukherjee also promised to raise $8.8bn from selling stakes in state run companies next year (he missed his privatisation target last year) and so far the $2.7bn Oil and Natural Gas Company (ONGC) 5% share sale is still slated for mid-March, though there are rumours it may be delayed a week or two.
But Mr Lalwani points out that the government is still reluctant to open the agricultural sector to foreign investment.
"That is where the real problem is in the food inflation - in the malaise in agriculture, the inadequate funding, the lack of irrigation, the cold storage, roads and so on, all of which push up prices and are a tax on the poor."
He pointed out that the Indian equity markets have recovered all their losses from the 2008 collapse, and are quite capable of staging a recovery from this relatively minor sell-off.
The World Bank is now forecasting that Indian growth will be faster than China's in 2012.
It's perfectly possible - it's just that there may be a number of upsets on the way.