Business Today

The fear is back

The eurozone crisis has sent stocks across the globe into a tailspin on fears of a double-dip recession. But though markets may remain jittery awhile, another global meltdown is unlikely.

Rajiv Bhuva | Print Edition: June 27, 2010

Market sentiment, most Dalal Street denizens will explain to you sagely, can be extremely fragile. Something that was on ample display in April and May. Just when the beat of the global economic recovery had the bulls gingerly emerging from the trenches, news of the sovereign debt crisis filtered in from Greece. And soon engulfed the PIIGS countries (Portugal, Italy, Ireland, Greece and Spain).

That was enough for the bulls to take to their heels again with a near-synchronous slump in major indices globally. Between April 1 and May 31, every global index that matters tumbled—the average fall was in excess of 11 per cent.

"There has been a correlated fall in indices," says Robert Buckland, MD and Chief Global Equities Strategist at Citi Investment Research. "People are shooting first and thinking later." In India, the Bombay Stock Exchange's Sensex, too, took the global cue and plunged over 9 per cent before staging a minor recovery.

Why the eurozone crisis has the markets worried.

The faultlines...

  • Sovereign debt crisis could spiral into another global systemic financial crisis
  • Euro slide takes toll on exportled Asian economies like China affecting corporate earnings
  • Stronger dollar accelerates deflationary pressures in the US, impacting the incipient recovery

...but for the global economy it’s not all gloom and doom.

  • OECD economic activity is picking up faster than expected
  • The affected PIIGS countries account for a minuscule portion of the world trade
  • The crisis is not brewing in the US—the heart of the global macro economy
The mammoth e750 billion, or Rs 43 lakh crore, rescue package from the European Union and International Monetary Fund failed to give an adrenaline shot to stocks. While it stabilised bonds, the equity markets remain edgy and nervous with investors worried about the possibility of revisiting the post-Lehman collapse scenario.

And by all accounts, say analysts, the skeletons of the sovereign debt crisis will haunt global markets awhile for a host of reasons. The biggest worry—European banks will need to roll over close to e800 billion of debt during 2010-2012, and to do so they'll have to compete with European governments that last year borrowed some e811 billion among them.

This competition for capital between the private and public domains could drive up interest rates, or even lead to a liquidity squeeze for the banks or the governments, or both. "There is a strong likelihood of sovereign debt crisis spilling over to renewed systemic financial crisis and global contagion," says Dhananjay Sinha, Strategist and Economist at Centrum Broking.

Also, the European dislocations have chances of transmitting the slowdown to the US. For a faster recovery, the US needs the dollar to remain considerably weak. But, in wake of the crisis, the weakening of the euro and a strengthening of US dollar will accelerate deflationary pressures in the US and is a cause for worry in an economy struggling with high debt and leverage levels. Simply, deflation increases the real burden of debt on an economy, while at the same time cutting into the income required to pay debt interest and principal.

Then, the euro crisis is stoking fears of an economic downturn in the world's biggest growth engine— China. The EU is China's biggest export market, accounting for 20 per cent or $236 billion of its exports last year. Chinese companies are now reporting losses because of the 15 per cent decline of the euro against the renminbi so far this year.

Ironically, the decision by the German government to stem the bloodletting by restricting certain forms of short-selling in euro area government bonds and German equities had the converse effect. "Initiatives to ‘kill the messenger' by prohibiting short-selling are likely to be ineffective and could raise some doubts about policymakers' willingness and ability to deal with their daunting public sector financial problems," says Michael Gavin, Head of Emerging Markets Strategy at Barclays Capital, in a report.

With no immediate "fix it" formula, market players believe that stocks would continue to feel the tremors of the crisis for a while. "This will test the patience of everyone," says Jagannadham Thunuguntla, Head of Equities at SMC Capital. But not many believe that we would see another global crash. For one, the sovereign debt crisis is not brewing in the US—which is the heart of the global macro economy. The affected eurozone countries have a minuscule share of global trade.

"The European crisis is nothing compared to the post-Lehman crisis," says Ritika Mankar, Economist with Execution Noble. Also, according to the latest Economic Outlook of the Organisation for Economic Cooperation and Development (OECD), economic activity among its member countries is picking up faster than expected—in fact, the growth projections have already been scaled up. Across OECD countries, average Gross Domestic Product (GDP) is projected to rise by 2.7 per cent this year and by 2.8 per cent in 2011.

India on Firm Footing

  • The economic recovery is gaining traction with India Inc delivering robust numbers
  • The 3G bonanza will help rein in fiscal deficit
  • Robust GDP growth—7.4 per cent in 2009-10 and 8.6 per cent in first quarter of 2010-11
  • Inflation rate is moderating


  • FII flows could be hit, making markets volatile
  • EU crisis brings India on the radar owing to its twin deficit and high debt levels
  • Robust corporate performance already factored into market valuations
Finally, globally the corporate earnings season has thrown a lot of positive surprises. Citi, for instance, has revised its global corporate profits forecast to 36 per cent in 2010, up from 29 per cent. "Corporates are working on 10 to 15 per cent lower cost base compared to 2007 levels," points out Citi's Buckland.

So, how does the global economic turbulence impact India and its stock markets? India's robust domestic consumption story is likely to cushion any blow by adverse global developments. India Inc. has been delivering stellar results in the last couple of quarters. "We don't see strong corporate performance going away over the next 12 months," says Ridham Desai, India Strategist and Head of India Research, Morgan Stanley. Inflation, which prompted the Reserve Bank of India (RBI) to begin tightening earlier than it would have wanted to, is now seen to be gradually getting reined in.

"Inflation appears to have peaked," says Rohini Malkani, India Economist for Citi, who believes that lower commodity prices would drive inflation down in coming months. The RBI is expected to avoid any adhoc tightening of interest rates to stave off the possibility of any global liquidity crunch impacting India. "The problems in Europe will result in lower rates for a much longer period. We no longer expect an interpolicy hike," says Malkani.

Another fillip for the market -The Rs 68,000-crore bounty from auction of third generation mobile phone licences will also rein in the fiscal deficit. Chetan Ahya, Morgan Stanley's Asia Pacific Economist believes that the central government's fiscal deficit should fall to 5 per cent of 2010-11 GDP, compared with earlier estimates of 5.8 per cent. "The consolidated fiscal deficit (including off-budget expenditure) would stand at 8.5 per cent of 2010-11 GDP compared to 9.2 per cent we had estimated earlier," says Ahya.

But despite a favourable domestic economic environment, the Indian stock markets are likely to mirror the global trend in the short term. "The Indian economy is insulated from the global shock to some extent but not its equity market," says SMC Capital's Thunuguntla.

Here's why: In the first quarter of 2010, markets were booming, driven by a surge in foreign institutional investor (FII) inflows in Indian equities. "Eurozone jitters have reduced the risk appetite leading to outflows taking its toll on the markets," says Aditya Narain, Head of India Research at Citi.

Adds Desai of Morgan Stanley, "Indian investors have become extremely cautious. Markets will remain volatile till the euro crisis plays itself out."

In the mid to long term, though, analysts expect the Indian markets to continue to trend upwards and outperform other markets. India commands relatively rich valuations, as measured by priceearnings multiples (P-E), compared to other developing countries—a premium given for its strong economy, insulated in large measure from global shocks. And analysts say it'll be a similar story going forward. "Once there is stability we'll see resumption of capital inflows," says Vaibhav Sanghavi, Director (Equities), Ambit Capital. Better-thananticipated results in the first quarter of 2010 has provided an earnings upgrade cycle which would provide further support to the market.

"Every bout of volatility and market dip makes the strong India story cheap for long term investors," says Ramit Bhasin, MD and Head, Markets (India), Royal Bank of Scotland. And if you were to go by Morgan Stanley estimates, the markets are heading for a 10 to 15 per cent growth over the next 12 months. "This is not a beginning of a bear market," says Desai.

A statutory warning—it could all go horribly wrong if more bad news trickles in from the eurozone.

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