Why upturn in stocks is premature

And other stories on the economy

Saumitra Chaudhuri

Last fortnight I had noted that “asset prices are going to continue taking a tumble.” But, in fact, prices have moved up since, and US and European bourses have actually wiped off much of the losses since September 11. This just underscores the danger of making unequivocal comments about equity price movements!

But I would stand by what I had written earlier. Asset prices will indeed slide as the war goes on. The recovery last week was driven by a set of perceptions which show that markets think in rather odd ways. After September 11, there was a widespread feeling that the US military action would be massive. Second, that all that could conceivably go wrong would indeed do so — a tribute to Murphy’s Law. For example, hospitals would get bombed instead of Taliban headquarters and the rest of the macabre tragicomedy. Third, governments other than the medieval Taliban would be drawn into conflict against the US-led alliance; that is, the scope of the war would broaden.

More than anything else, this reflects on how deeply the financial community was convinced of the gun-slinging belligerent image of the present US administration, of general governmental and military incompetence, and how greatly they underestimated the opportunism of authoritarian regimes in the Muslim world. With the horror fantasy not materialising, the markets appear to be now in the grip of a new set of misconceptions. That the war is all but won — the myth of the “short” war. That the scope and intensity has already been fully defined. Unfortunately, facts are quite otherwise, as Messrs Bush, Blair and Rumsfeld have been repeatedly telling us.
The air strikes, which have apparently gone according to plan, are perhaps the easiest part. The ground war — and unlike in 1991, there will be a lengthy one — is something about whose contours we can only guess at, but know too little. Many things can go wrong in the Afghan theatre, not of the “all thumbs” type, but a consequence of the complexity of competing interests: The large number of factions involved, the difficult terrain and the morals of a key neighbour which would shame a brigand. As for the scope of the war, of course it is virtually certain to expand. So, asset prices will indeed slide and economic growth and trade outlook will be dismal for some time to come.

During the last fortnight, several key indicators of the domestic economy for the first quarter of 2001-02 have been released. Gross domestic product growth for the quarter has been put at 4.4 per cent, one percentage point higher than most people, including me, had expected. Why did we all go so wrong? The answer lies in the agricultural sector. The data that was available indicated a rabi foodgrain harvest of 93 million tonnes for the season ending June 2001, that is 10 per cent lower than last year; also that cotton and some other cash crops had done poorly. From this, it seemed reasonable to conclude that agricultural GDP for the quarter would contract by 2 to 2.5 per cent.

Surprise of surprises, it was quite the obverse: agricultural GDP was reported to have increased by 2.3 per cent! What happened? Who knows, but one hears that the rabi foodgrain harvest for last year has been significantly revised upward. That would actually make sense, given that rabi procurement was 4.5 mt or 20 per cent more than that last year. By the way, if indeed such a revision in the last rabi harvest has been made, it will up both the fourth quarter and full year GDP growth rate for 2000-01.

The Reserve Bank of India released the balance-of-payments statistics for the quarter April-June 2001. The Current Account Deficit was down to $332 mn from $1,970 mn in the first quarter of 2000-01. What contributed to this bridging of the gap? First, a smaller merchandise trade deficit ($861 mn), second a lower deficit in investment income ($488 mn) and finally a higher surplus on private remittances ($342 mn). What about software exports, the reader would surely wonder. The head “miscellaneous general services” includes software earnings, but also expenses of Indian companies overseas, and other items. Since net surpluses have declined somewhat, one can only conclude that the increase in software exports is being more than offset by other kinds of expenses. With such a small CAD deficit in the first quarter, and low reported trade deficits up to the end of August 2001, it is quite possible that the full year will actually see an improvement over 2000-01, when the CAD was a mere 0.5 per cent of GDP.

There has been sporadic good news from month to month — higher truck, cement, car sales. Not much ought to be read into these, unless there are signs of sustained expansion. Were this to happen, even then, expect only a modest and short-lived upturn.

Saumitra Chaudhuri is economic advisor to ICRA (Investment Information and Credit Rating Agency) and editor of Money and Finance, the ICRA bulletin.