Tuesday, April 04, 2006

Risks to the Indian Financial Markets

The Indian Markets continue to surprise even the most ardent bulls. Surely there is growth, and surely there is a huge middle-class population that is discovering the joys of spending for the first time. But the march of the BSE Sensex from 10,000 to 11,000 in 25 odd trading days, and then the march from 11,000 to 11,600+ in 3 trading days has been unexpected, to put it mildly. Will this be a case of the higher they rise, the mightier they fall? Is there so much liquidity in the Indian markets currently - Reliance recently raised $1.3Bn from domestic investors for its Reliance equity fund, $1.3 billion is close to 1 day trading value on the Indian bourses - that the markets have become entirely liquidity driven?

Here, I list a few near-term events that could cause the Indian markets to correct sharply. Others are welcome to chip in.

A) Political elections: Currently, there are state assembly elections scheduled in Tamil Nadu, Kerala, Assam (already on) and West Bengal within the next few months. Predicting the Indian elections is at best, a guessing game (In 2004, psephologists widely predicted that BJP would win the national elections by a wide margin on back of 'India Shining' campaign, only to see it lose. Recall the Sensex plunged by over 10% that day of May 17, 04). Still, surprises in Kerala and West Bengal - which are the bastion of Communist parties (a key coalition partner at the centre) - could result in some interesting dynamics at the centre.

B) Increase in Japanese Interest Rates: Japan has been a very big investor in India, so an increase in interest rates there, as has been indicated by the Japenese Central bank, could have a negative impact on the Indian markets. One could, however, also argue that an increase in Japanese interest rates signals a confidence by the bank in Japanese economic recovery, which could turn out to be a big positive for the Indian economy in the long run. Similarly, higher interest rates in US and Europe could make foreign investors look at their own countries than to India.

C) Failed Monsoons: Agriculture contributes nothing to the Indian growth story - the 8% GDP growth number is all off services and manufacturing. But a failed monsoon will have wide repercussions for India - estimates range from 35% to 60% of the population as still dependent on agriculture. Rains normally arrive in late May.

D) Terrorist attacks: Within India, terrorist attacks have so far been taken in stride. Outside India, London attacks did not deter the markets worldwide. So unless there is a major geo-political crisis (Iran, Iraq?) that suddenly increases the risk profile of investors world-wide to go up sharply, this would be a non-event.