The Babbling Markets: Profitability still a concern
The equity markets showed a steady downward trend throughout the week with brief rallies emerging on Wednesday, due to the news from Iraq and on Friday because of the US numbers, but it petered out pretty quick, says Dr Bhaskar Dasgupta.india Updated: May 31, 2003 12:19 IST
While the US numbers displayed strong retail sales and an upbeat consumer sentiment gave a bit of a reason to hope for the US economy, profitability is still a concern with widespread apprehension that a significant chunk of the corporate sector will be reporting reduced
The UK market was more volatile, as was the Footsie Eurotop 300. Japan dived deep with pension funds carrying out heavy selling of blue chips with the sad result that the Nikkei dropped to a 20 year low.
There is still a small but significant capacity hangover in the US, while the Euro zone countries have a much bigger over capacity overhang.
Unemployment and bankruptcy figures are still trending upwards. In March, the US employment figure dropped by 108,000 workers while February's figures were revised up to 357,000.
The International Monetary Fund released its Global Economic Outlook for 2003 this week and cut its headline global growth forecast from 3.7% to 3.2% due to worries about Iraq and the general stock market declines. For the USA, the report gives qualified approval to the tax cuts, but expressed concerns for monetary easing and potential long term impact of the tax cuts.
The German economy was a concern with a stagnant economy and stressed banking sector. While saying that, analyst's reports this week gave an upbeat indication on several European Banking and Insurance stocks. The IMF also expressed concerns about the structural deficits, but danced around the Stability and Growth Pact straight-jacket, which the European economies have put on.
The old problem of structural rigidities in the product and labour market was again raised. There was overall satisfaction with the emerging markets fiscal and monetary policies but with wide variations across this group.
The retreat of Gold and Oil
Two sets of US numbers, strong retail sales and an upbeat consumer sentiment survey, caused the US Dollar to strengthen against the Euro, although next week's earnings report will be key in maintaining the market sentiment till the end of this quarter.
The near end of the Iraq War has caused the premiums in Oil and Gold to reduce, while Gold is retreating from the dizzy heights achieved in February, it is not retreating to that extent, in fact, it showed a small rally this week, as the underlying global economy is still weak and political uncertainty continues, albeit at a lower level.
Oil markets retreated with the forward four month contract dropping to $24.75. It has breached the lower level, where OPEC starts getting concerned and murmurs of production cuts have started to surface.
Bonds were trading with volatile movements in relatively thin markets with conflicting signals coming from the war as well as from the equity markets.
The US figures did give a bounce to the equity markets, but it quickly petered out. With the anticipation of a messy peace coming to the fore, the bond markets seem to be staying in volatile territory over the next few weeks. French inflation was higher and this drove the Euro bond markets down a bit, as did the gilt markets, due to the brief UK rally.
WTO's good news for India
Indian markets continued their slow trend down, although the feeling in the market is that there is going to be a technical correction soon. On the WTO front, there was good news for India, where the Appellate Body ruled against the European Union on the anti-dumping duties imposed by the European Union on imports of cotton-type bed linen from India.
Pakistan and Egypt, the other two major bed linen exporters to the European Union are also peripherally involved in this case.
On an overall basis, this is a good step, since India has been aggressively using the legal measures under the WTO to protect both its domestic as well as its export industry.
It should be noted that the feeling in the European Union is driven to a considerable degree with its desire to protect its pampered agricultural sector, and its worries that if agriculture is thrown open to the WTO framework, the impact of anti-dumping and legal aspects will cause severe political problems within countries such as France, Germany and Greece.
Elsewhere on the trade front, the USA has come out with a statement which asks for capital controls to be removed within free trade agreements. This is a significantly dangerous step, especially for budding economies such as India, where the financial markets lack depth. Sudden withdrawal of international funds from the economy can have a seriously deleterious impact, which can take years to put right.
Good news also from the Indian Gems and Jewellery sector with a 21% increase in exports to $9.1 billion.
Now let us take a peek from the trenches to the ivory towers. A recent working paper authored by Julian di Giovanni of the University of California at Berkeley, entitled, "What Drives Capital Flows? The Case of Cross-Border M&A Activity and Financial Deepening", looked at Foreign Direct Investments (FDI) by firms in an interesting way.
Usually, one looks at factors driving FDI, such as legal frameworks, capital and profit repatriation, infrastructure, energy and basic feedstock availability and the like of the recipient country.
Professor di Giovanni looks at this flow from the source country's perspective. In particular, the size of financial markets, as measured by the stock market capitalization to GDP ratio and the credit provided to the private sector by financial institutions to GDP ratio in the domestic economy, have sizeable positive effects on the incentives for domestic firms to invest abroad.
Other factors which seem to affect cross border flows are bank credit availability (although stock markets are more important than banks as a financing method), tax rates (high tax rates relate to lower FDI), trade agreements (presence of trade agreement increase FDI), common language (increase in FDI), skills availability (higher skills relate to higher FDI).
Interestingly, Professor di Giovanni doesn't find the exchange rate to be a factor in FDI decisions, which has interesting implications for India. India is usually not considered to be a source of FDI, but it has started to become a serious player (for low income countries) in the world markets.
Our industrial base is still too dependent on bank funding with its consequent impact on public finances. Take for example the recent RBI proclamation that the ceiling on credit facilities to Indian Joint Ventures was being raised from 5% to 10%.
This is concentrating on bank finance while, ideally, financing should be raised from the capital markets. While SEBI has made attempts to reform our capital markets, there is a long way to go before we can achieve a situation where raising funds is as easy as in the countries with large outgoing FDI.
(Dr Bhaskar Dasgupta works in the City of London in various capacities in the banking sector. He also lectures at several British Universities. He holds a Doctorate in finance and artificial intelligence from Manchester Business School and is currently working on another doctorate at Kings College in international relations and terrorism.
He will be writing a weekly Monday round-up on markets and indicators.)