Sensex And The Real Economy

India’s stock markets are rocking! While the BSE Sensitive Index breached the 17000 mark on Wednesday having notched up more than a 1000 point rise in just five sessions of trading, the Nifty (NSE 50-stock index) breached the 5000 mark on Thursday confirming that the country’s capital markets are going through an unprecedented bull run. This article takes stock of the current situation and the likely outlook in the near to medium term.
According to most experts, the current bull run is primarily being fueled by foreign funds rushing into the economy due to the strengthening rupee vis-a-vis most major currencies, especially the dollar as well as the “subprime crisis”: that has made investments in the US unattractive. Hence, investors can expect the “markets to go into correction mode”: sooner than later. It’s just a matter of time before investors run out of investible funds.

While capital and financial markets often show a lot of volatility due to investor sentiment, ultimately it is the real economy that rules. Looking at things from that angle, many investors are likely to remain very bullish given the very positive medium-term outlook that the economy seems to be presenting. In fact, finance minister Mr M.A. Chidambaram, in a speech today on “India: Economic Growth and Outlook”: delivered at the Peterson Institute for International Economics in Washington, United States said unequivocally that the medium term economic outlook for India was very positive and he went to list a whole slew of such positives covering almost all aspects of the economy.

The other key factor regarding the real economy that investors have to factor in is the outlook for the US economy. Again, there are optimists who believe that with the Federal Reserve Bank of the US cutting both the benchmark rate and the discount rate with another rate cut possible at the end of October, the US will be able to stave off recession.

Again, it should be remembered that it is the real economy that actually rules the roost. While monetary policy can stave off recessionary pressures in the short term, if the real economy is not performing well, rate cuts are not going to help. And, by all indications, the real economy in the US is not doing too well. That means fears of recession are real and are unlikely to go away in a short while. While some economists believe that it is likely to be a matter of “one quarter of weak growth,”: there are others, including the editor of The Economic Times, Swaminathan S. Ankleswaria Iyer, who believes that “recession in the US is a real and present danger”:,curpg-1.cms and that the US may have already slipped into one with the latest job data indicating a fall in employment.

If the US does go into a recession, there is no reason to think that it will not have an impact on the Indian economy. Gone are the days of self-sufficiency, and, today, the export to GDP ratio in India is as high as 45%. That means, with the US being one of India’s largest trade partners, any recession in the US would certainly affect fortunes here.

On balance it seems it would be prudent not to get carried away by the current market euphoria. Although the Indian economy seems to be on a very strong wicket, the same cannot be said about the US economy. Even the Fed chief Ben Barnanke has warned that uncertainties remain, that the subprime crisis has spread through financial markets and there could be “worrying consequences for economic activity”: all of which indicate that a recession in the US is definitely a real and present danger.

No doubt the India growth story will go on irrespective of whatever happens in the US. The fundamentals are too strong to think that there is anything to worry about in the somewhat longer term but the immediate short term and medium term can witness some real volatility. Just as the present bull run is unprecedented, we may also see some unprecedented volatility. Long term investors need not worry, but those who think of quick churns in their portfolio to create wealth should be wary. In the time of general euphoria, the wise stay cautious: that’s an old market saying! No harm in heeding that!