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Why the Indian markets are falling

June 9, 2008

It all started with the US subprime problem and the global credit crunch, which led the BSE Sensex nosediving from its peak of 21,206 on January 10, 2008 to 14,677 on March 18. A part of the fall can also be attributed to the concerns pertaining to the increase in crude oil prices and its impact on India's economic growth.

Some of the early signs were also visible from rising inflation and the slowdown in domestic industrial production numbers. This further led to concerns over high interest rates, slowdown in GDP and thus, corporate earnings as well.

Sensing these developments, foreign institutional investors were the first ones to move out of the market, and they partly became the reason for the markets to fall.

End of the bloodbath?

If the global and domestic problems persist, experts predict the Sensex to fall to 12,000-14,500 levels. Though bold and unbelievable, there are few players who are predicting that the Sensex may touch the 9,000 levels.

While we are not predicting the Sensex levels, we jot down and bring certain factors that may determine the future course of the markets and what investors should do during these uncertain times.

Crude realities

No investor will be willing to invest in an asset headed for reporting lower profits and no asset can be profitable if costs are higher than realisations.

Crude oil is one such commodity, whether it is the economy (macro) or corporate profitability (micro), which is considered to be the source of most of the problems.

While crude oil prices had corrected to $125 levels, after crossing $135 a barrel mark, it again scaled a new peak of $139.12 a barrel last week. There are reports predicting that it will go to $150 to $200 a barrel.

There are several reasons attributed to the recent spike in the crude oil prices including increased financial investments and a marginal rise in costs of oil production.

Whether the crude oil price rises to such high levels or not, experts suggest that the good old days of cheap oil may be gone for a long time to come.

Bloating deficit

According to studies, a $10 increase in the crude oil prices may reduce India's GDP growth by about 0.3 percentage points and an increase in the consumer price index by 1.2 percentage points.

India imports about 70 per cent of its oil requirements, suggesting that at current levels, it will have to pay a significantly higher amount to meet demand. It has already led to a large trade deficit (over 7 per cent of the GDP).

Fiscal deficit, which is currently at about 3 per cent of the GDP, could reach to 10 per cent levels if the fertiliser, food, farm and oil subsidies are added.

Hence, further rise in crude oil prices will only make things worse. Not only this, rising oil will have serious consequences on others things as well.

"If crude oil touches $150 levels and sustains there, it will be a crude awakening for the global as well as for India. India's annual import bill will touch to $140 billion against the $78 billion estimated for the FY08," says Devendra Nevgi, CEO and CIO, Quantum Mutual Fund.

High inflation

High crude oil prices would have a sweeping impact on the Indian economy.

To put forth some of them: Higher inflation rate, rupee depreciation, increasing trade account and fiscal deficit, and firm interest rates. The other side of an oil shock would probably the ensuing political instability and social unrest.

The inflation rate, which is already high at over 8 per cent, could emerge as a key concern. Economists share different views with regards to inflation reaching the double digit figure in the short term, and if not, it could range at about 7-8 per cent, especially after the recent hike in the petrol and diesel prices.

Text: Jitendra Kumar Gupta, Business Standard

Image: Indian investors react as they view share prices on a giant screen outside the Bombay Stock Exchange | Photograph: Indranil Mukherjee/AFP/Getty Images

Also read: The 10 biggest falls of the Sensex
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