In the past decade, given its Demographics, Rising Income of Middle Class, Growth Potential and strong Economic Fundamentals, India emerged as one of the favorite Investment destinations. The Economy has foregone tremendous transformation and has witnessed robust capital inflow during the same period. Indian Economy was also one of the very few economies which showed tremendous resilience during the financial crisis. What makes India so attractive is the fact that Indian growth story does not rely much on Exports and is more inclined towards robust Domestic consumption. But, recent economic data shows that India’s greatest strength as an economy (reliance on domestic consumption) could in fact become a hurdle towards its growth going forward.
The Financial Crisis of 2008 highlighted two aspects of Indian Economy; Demographics could sustain consumption growth and Domestic Demand could help withstand slowdown. While these two factors are a huge positive for India, the real problem with our Economy today is that of “Falling Consumption Power within the Country”. Headline inflation of India is at 9.03% and is expected to rise further given the recent move by Government to hike Diesel, Kerosene and LPG prices. While this is estimated to impact inflation by 100 basis points, the real impact of the same would be much more. Transportation in India impacts virtually everything. Since the price of Diesel has been increased by Rs. 3, this would impact the cost of all goods and services in India. What would definitely be impacted is the cost of running a household, which for a common man is going to be impacted severely. This would definitely have an impact on the Consumption Power of the Citizen.
What has gone unnoticed is the fact that with the recent price hikes by Government, the fiscal deficit of the country would widen more. If Inflation begins to inch up higher, this would result in another series of rate hikes by the RBI which would begin to impact the growth of the Economy. Forecasts for the growth rate of Indian Economy were pegged at 8.3% for 2011 – 2012. But, after the recent quarterly growth rate of 7.8% and the recent price hike by the Government, these estimates are bound to be revised down wards. Though India still remains a viable investment destination, a lot has to be accounted for given the high estimates investors had about the growth rate of the economy. Inflation clearly has resumed its uptrend and is unlikely to cool down given the macro economic scenario. A lot now depends on Monsoon, which I believe has always remained difficult to predict.
India Inflation Rate (Source: TradingEconomics.Com)
So, where does India go from here? And what would be the implications on Stock market? Well, this is one question which is difficult to answer at this stage. The effects of mounting inflation and the steps which government is taking to counter the same can have disastrous effects if their action yields no result. India this year has been one of the worst performing stock markets and given the macro headwinds ahead, it does seem it will likely remain the same. Political pressure on the government is rising as well and in the worst case scenario, political instability cannot be ruled out. There are host number negative factors which the stock market has not yet discounted and hence if those negative factors such as double digit inflation, sub 8% GDP growth, lack of policy action and political uncertainty begin to play out, then India could see further correction in months ahead.
India GDP Growth Rate (Source: TradingEconomics.Com)
Government is increasingly “preoccupied” with dealing with corruption related issues and is inactive on policy front. The real issue of corruption and the monetary loss to the country remains largely unsolved as currently the government is only concerned about guarding its own image. Moreover, image of our Prime Minister as a muted spectator is not going down well with the Investors. Under such circumstances, betting big on India at this stage certainly requires lot of courage. After all what markets have discounted at present can never be predicted. Economic problems for India are here to stay and given the complacency of our government on numerous issues, Indian Economy perhaps faces some of the biggest challenges it has over the past decade.
I wish I had read this article earlier. Indian Economy is reeling under pressure. What is your take on stock market now. I read in recent article that you are cautious but not bearish. Kindly explain