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Conflicts In 2011

| 1/31/2011 10:05 AM Monday

- By PRASHANTH NARAYAN
VP & Head - PMS Investments, ING Investment Management India


2011 seems to be a year of contrary thoughts. On the one hand, the global economy seems to be shaping up better than expected and this global recovery seems to be adding some risks to the domestic markets. The global economy and the US in particular are showing stronger signs of sustained recovery. On the other hand, quantitative easing as well as expectations of better global economic growth is pushing the inflation high-er, especially via higher oil prices, in emerging markets and especially India. This structural inflation risk and a better global economic growth might lead to partial money flow out of emerging economies and into developed economies.

However, real indicators such as employment and retail sales have not yet improved significantly for the US and the euro area. Unemployment in the USA is stubbornly high and any pretense of the Fed being concerned about the dollar’s exchange rate has disappeared. In fact, the US authorities in general are unaware or do not care that a weaker currency leads to imported inflation.

The Euro economy still continues to remain on a slippery slope. European sovereign debt crisis will probably continue to be negative, despite efforts from the EU region to contain the sequence of fiscal crisis the European economies are facing.  In both the UK and the Euro zone, inflation has risen over the target ceiling rate of 2 per cent, especially in the UK and all logic says that a rise in rates is likely in 2011, led by the BoE. US FED will probably be the last to follow this chain of inter-est rate increases.

The Indian economy in itself is facing the opposing trends. The economic growth has been healthy and might continue to grow at a pace of 8 per cent in FY12. However, there are short-term resistances, which, if not managed, can become structural. First such issue is the balance between liquidity/interest rates and the structural inflation. We have always noted that the inflation India is facing is structural due to rising global commodity prices and excess global liquidity due to quantitative easing. The second such issue is the lack of capital goods formation in the country primarily owing to a lack of clarity in policy and execution. Recent issues in corporate governance will act as a short-term drag for foreign fund flows.

Despite these resistances, given the state of the global economy, Indian economic growth is healthier and robust as compared to its emerging market peer group. Domestic consumption is growing at a very healthy rate and is more than ever supported by growth in the rural India. We also anticipate that capital expenditure might gradually increase over this year but might face policy-related resistance.

Gold and precious metals might face some resistance given that the confidence in the global economic growth is slowly increasing, however the waning impact of US QE2 and the EU area risks will provide a sup-port for gold. On the rates front, tight liquidity still continues with the central bank coming up with measures to ease the liquidity situation with Open Market Operations (OMOs) of Rs 48,000 crore and reduced the SLR by 1 per cent.

 

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