The odds are even that Indian markets will do better in 2012

Can India do better in calendar 2012 in terms of market performance? The positives for India going into 2012 are prospects of inflation and interest rates coming off and softer monetary policy across emerging economies.

The negatives for the country going into 2012 are weak government finances, lower growth on spillover effects from 2011 and no resolution to the eurozone debt crisis. Predicting the way the positive and negatives pan out is an imperfect science, but if one goes against the extreme pessimism which is ruling the markets at present, one can predict that 2012 will be a better year for Indian asset classes.

India has clearly underperformed

[caption id=“attachment_146285” align=“alignleft” width=“380” caption=“Indian equity, currency and bonds returned negative over the period as inflation, rate hikes, fiscal deficit, scams, bad loans, and eurozone debt factors took hold of the country. AFP”]  [/caption]

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Indian asset classes were one of the worst performers in 2011 (as of end November 2011 on a year-on-year basis). Indian equity, currency and bonds returned negative over the period as inflation, rate hikes, fiscal deficit, scams, bad loans, and eurozone debt factors took hold of the country.

Inflation ruling at over 9 percent levels for most of 2011 prompted the Reserve Bank of India (RBI) to hike the benchmark repo rate by 200 basis points (2 percent) in the calendar year to date period. The deep holes in government finances, which has prompted the government to increase budgeted 2011-12 borrowing by Rs 53,000 crore already, has led to a rise in government bond yields to multi-year highs.

The country also suffered the headlines of the 2G scam where key politicians and corporate leaders were involved. Banks faced the prospect of rising bad loans with the country’s largest bank, State Bank of India, showing rising NPAs (bad loans), with gross NPAs rising to 4.19 percent as of end-September 2011 from levels of 3.35 percent seen last year.

To top it all, the eurozone sovereign debt issue, where bond yields of Europe’s third largest economy, Italy, rose to unsustainable levels of 7 percent, hit risk assets, including the Indian rupee, hard.

Prospects of inflation and interest rates coming off in 2012 are good

If inflation does ease to 7 percent by end-March 2011 and stay down, the RBI can ease policy rates in the second half of 2012.

The RBI had indicated in its last policy review in October 2011 that it is likely to maintain policy rates in the next few reviews. The RBI had hiked the benchmark repo rate by 25 bps (0.25 percent) in October 2011, taking the total hike to 375 bps (3.75 percent) over a 20-month period. The RBI believes that inflation, which is ruling at 9.7 percent levels (as of October 2011) is likely to trend down to 7 percent levels by March 2011. Economic data will support the RBI if it decides to maintain policy rates. IIP (Index of Industrial Production) growth for September 2011 was at 1.9 percent against 6.1 percent seen in September 2010. IIP growth for the April-September 2011 period has come off to 5 percent against a growth rate of 7.8 percent seen in the same period last year.

GDP growth for the second quarter of fiscal 2011-12 came in at 6.9 percent against a growth rate of 7.7 percent in the first quarter and a growth rate of 8.8 percent in the same period last year. GDP growth estimates for 2011-12, has been revised from 8 percent to 7.6 percent by the RBI and all macro indicators are pointing to GDP growth coming below 7.5 percent levels.

Credit growth on a year-on-year basis has slowed from over 22 percent levels to 17.5 percent levels over the last seven months. Global growth forecasts have been reduced by 30 bps for 2011 and 50 bps for 2012 by the IMF due to debt worries across nations. A slowdown in global growth will hit India’s trade as well as capital flows leading to domestic growth slowdown.

Rate cuts by central banks across economies

Central banks from Brazil to Indonesia are looking to ward off growth fears rather than inflation fears. Emerging economies were hit hard by inflation in the last one- and-a-half years, with inflation ruling at multi-year highs across economies. Central banks in the BRICs (Brazil, Russia, India, China) have all raised rates over the last one- and-a-half years to ward off inflationary pressures.

However, the tide seems to be turning, with growth rather than inflation taking centrestage. Brazil, Indonesia, Russia and Thailand have seen rate cuts over the last few months by their respective central banks on the back of eurozone debt fears bringing down growth expectations. China, which had been running a tight monetary policy until November 2011, cut the reserve requirements of banks by 50 bps in order to ease liquidity.

The reversal of policy stance by China is positive for the global demand. Rate cuts by central banks in emerging economies could lead to improving sentiments in the markets.

Eurozone crisis will not go away but it can ebb in intensity

The EU (European Union) leaders are still grappling with the debt crisis in the eurozone. The spread of the crisis to Italy has caused a big turmoil in markets as Italy paid over 7 percent rates for issuing fresh debt. Italian bond yields have gone up by almost 250 bps since the crisis hit the markets hard in August 2011.

EU leaders are talking of a larger role for the IMF (International Monetary Fund) in solving the debt crisis. The size of the bailout fund, the EFSF, (European Financial Stability Facility) is also likely to be shored up to prevent the debt crisis from spreading to other large economies such as Spain. The role of the ECB (European Central Bank) is yet to be fully determined in containing the crisis, but if the ECB does get involved and play a larger role, it will be very positive for markets.

You can view the performance of global markets, currencies and bonds here .

Arjun Parthasarathy is the editor of ** www.investorsareidiots.com,**a web site for investors.