India’s fiscal position suggests caution: Moody’s

18 Jun 2009,ET Bureau

MUMBAI: Indian equities have rallied sharply in the last three months despite continuing risks to both the global economy and India's outlook.
Investors took solace in India's relatively mild downturn and chances for faster recovery. However, Moody’s Economy.com warns that the country’s fiscal position suggests caution, as the government is not in a position to offer sustained support to a weak economy.

The surge in Indian equities over recent months has been met with jubilation from investors, but possibly also some caution. Despite some retrenchment in recent days, the Sensex is up 83.4 per cent since March 9; it has now returned to levels seen in September of last year.

Considering the dire scenarios that some were factoring into stock prices earlier this year, the rebound is not surprising. Yet there are several reasons to be skeptical about continued equity market improvement, believes Nikhilesh Bhattacharya, associate economist at Moody’s Economy.com.

According to Bhattacharya, “The major reason to question the strength of the recent rally is the state of the global economy. The developed world is still in recession, relying on fiscal and monetary stimulus on a scale unseen since World War II. Central banks and most independent analysts expect high unemployment, aversion to risk, and excess capacity to weigh on future growth. A recent discussion piece by International Monetary Fund economists showed that equity prices tend to bottom only at the end of a recession brought on by a credit crunch and asset price bust—not prior to the end.”

However, Bhattacharya sets a counterargument that India's downturn has bottomed and was mild compared with other countries. Based on first quarter GDP numbers, this appears to be the case. Yet Indian equities tend to take their lead broadly from US stock market movements, and it is hard to envisage a sustained divergence in direction, even though emerging markets can amplify US trends.

But India's economy faces its own challenges. “An already-stretched fiscal position has limited the government's ability to provide further stimulus, while weighing on government bond prices. Excess capacity, slowly recovering external demand, and relatively high long-term interest rates will drag on investment. Although the government has a strong majority in parliament, political will is required to cut popular subsidies and modernise labour laws. With global recovery prospects uncertain, these are further reasons to be cautious about Indian equity prices,” Bhattacharya concluded.