It?s a tad ironical that investors are scrambling for the same US Treasuries that were downgraded by Standard & Poor?s just last Friday; the yield on the 10-year Treasury slipped from 2.57% on Friday to 2.3% on Monday, the very same day on which every single one of the 500 stocks in the S&P closed in the red and the Dow came crashing down 600 points. Such is the fear in the minds of investors in the US that they?d rather stay put in government bonds than risk equities even if the yield on both the S&P and Dow is now higher than the yield on Treasuries. Never mind that Bank of America is trading at 0.4 times book value. That?s actually true for much of the world; fund managers are moving money either to German Bunds or the Swiss Franc?trading at record levels to the greenback?or gold. Right now, they?re unwilling to bet on the ability and willingness of the heads of the larger economies in the Eurozone to bail out their poor cousins?Italy and Spain. Moreover, they?re not sure how the US Federal Reserve and the Obama government are going to be able to breathe life into the moribund US economy without once again creating a bubble in commodities. Perhaps the Fed Chairman Ben Bernanke will have some ideas to share with the markets after the Federal Open Market Committee meets but until then, given the extremely bleak outlook for growth, equities are clearly not the flavour of the season.

The US is likely to see anaemic growth this year and the June quarter earnings season hasn?t really been too reassuring. So, while the second half of the year was to have been better, especially with the reconstruction in Japan driving up demand, the weak Q2GDP, which came in at just 1.3%, is a sign that things may not really look up for a long, long time. If the US is going to keep spending in check, it could mean lower demand at home. Indeed, as has been pointed out by experts in the West, policy paralysis has a lot to do with the current state of near panic in the markets, whether it?s the leadership in the US or in the Eurozone.

Unless this leadership reassures markets that it has a plan in place to tackle the crisis, the precarious finances of the western world will make it harder even for the Asian economies to grow at the kind of pace anticipated just six months ago. Although countries like China have grown at 9.5% in the June quarter, despite the continuous monetary tightening over the past year, the falling demand from western markets will hit exporting nations like South Korea even if there is increasing demand within Asia, especially in large economies like China. As economists have pointed out, policymakers in China are focusing on creating demand at home so as to cushion the impact of weakening demand from the western world.

India, too, is largely insulated, with exports accounting for about 18% of GDP. However, GDP growth in the recent past has been driven mainly by consumption rather than investment; consumption is slowing and so is capacity creation, as reflected in the sluggish credit offtake from banks, which rose at just 16% in the first few months of 2011-12. So, while GDP growth estimates may have been reduced to around 7.5% or thereabouts, for 2011-12 there is now a possibility that even this will not come through unless capital formation starts picking up fast. Industry is already paying very high rates to borrow and is hampered by the lack of clear policy guidelines and slow pace of clearances. There has been some action of late, which is one of the reasons why Goldman Sachs upgraded India to marketweight but much more has to happen before industry gains the confidence to start investing in capacity.

Of course, the majority of Indian companies today are far less leveraged than they were in late 2008 (a study by Morgan Stanlay shows that cash holdings are at twice the levels they were in 2008-09); after the 2008 crisis, Indian companies bounced back very quickly to post strong earnings?Sensex earnings grew at around 23% in 2010-11?which is why the market attracted $28bn worth of foreign flows last year. The market has already priced in a slower earnings growth of 16-17% in the current year but further downgrades could mean that the Indian market runs the risk of being de-rated at a time when risk aversion is rising globally. To be sure, India today looks a better bet than any other market except probably China, which is why it still commands about a 18-20% premium to peers in the region. Falling crude oil and commodity prices will make it even more attractive because inflation would fall, creating more consumption demand. Moreover, corporate results show that top lines have risen smartly but margins have been pressured by high input costs?gross margins especially have seen a sharp drop. After about a 20% correction in the market from the peak in early November last year, the market may not be dirt cheap but there?s clearly good value in Indian stocks?several promoters have cashed in on the opportunity to buy back their stock. Much depends on how quickly the US and Eurozone find an answer to their problems; but once risk aversion falls, India will be on the radar of fund managers.

shobhana.subramanian@expressindia.com