The focus of the equity markets is singularly on one thing at this point in time – when are we going to be fully open both in India as also elsewhere. A very pertinent question, as that alone would determine the extent to which economic growth can rise and inflation could also. There is another reason behind these questions. It is because with the rise in growth and rise in inflation there will be policy changes that may lead to normalization of liquidity conditions gradually. It goes without saying that the rise in asset prices has been facilitated by the excess liquidity in the system in the last couple of years. Even with normalization of liquidity, if the economy grows and continues to do well, it will be positive for the markets in the long run, once we get over the issues relating to tapering of liquidity by central banks. The liquidity conditions and the low interest rates in the domestic market will continue to be the main supportive factors for the market as the RBI policy has reaffirmed the need to ensure sustainable growth as a policy priority compared to inflation. Only in case of consistently high inflation that the RBI would be forced to make early changes to its current stance.
Yet another factor that lends better support to the markets has been the earnings results for Q4 FY21. To a large extent these have been in line with expectations carrying it forward from Q2 and Q3 of FY21. Though, there is reasonable potential for some hiccups on account of the second wave of the pandemic which we have narrowly come out of in the last two weeks. This may have some impact on performance as the lockdown has brought to a standstill some of the top cities and towns in the country which account for a significant share of business of corporates. However, assuming that we may be able to thwart the third wave or contain its adverse effects, the earnings prospects for the coming two years would remain quite robust given the pickup in the leading economies in America and Europe.
There are many other positives that we could see, like the improved health of the banking system with better control over the non-performing assets, and the expected credit growth rates. The contribution of agriculture to the GDP remained positive even under the most stressful conditions. With normal monsoon expected it should add some sheen to the rural economy.
Immediate risks to the economy and the markets come from several factors of which the high commodity prices is one. The oil prices are moving up and the Rupee is relatively weaker, and this may have an inflationary impact and if it persists then it could lead to measures from the RBI by which to contain the inflation including gradual normalization of liquidity. Another factor that may be of consequence to the markets is the Fed policy in the ensuing months. There are indirect indications of an impending normalization with a fast pace of growth and an equally challenging rise in inflation. Fed action may come sooner than expected and this may have consequences for the liquidity flow into the emerging markets. Fed unwinding may have an impact on currency markets too as with rising rates in the US the currency yield goes up and this lends strength to US$.
The sentiment is positive, but it cannot be ruled out that there may be a good number of people who are on the sidelines waiting for a meaningful corrective downward movement. The market has priced in almost all the known factors and the likely triggers in the near term. But ultimately there is one factor that is the most important determinant of where we are headed. And that is how we are going to combat the recurrent waves of the pandemic through universal vaccination. While making investments the focus should be on well diversified portfolios.
