The Reserve Bank of India just cut rates by 25 basis points. Earlier, government officials had been suggesting more rate cuts were necessary and forthcoming. Then, in the previous few days, it seemed that the consensus among analysts was that the RBI would hold rates steady. One senior economic advisor suggested to me last week that, since the interest rate channel is weak, the RBI might just reduce the cash reserve ratio (CRR). As it turned out, the RBI left the CRR unchanged, but made a smaller than typical (in recent months) interest rate cut. Already, forecasters are suggesting that another small cut will be made after the new government takes over and offers a full budget. Politically, the timing may make sense, but I continue to be puzzled by the strategy of gradual cuts, when there is a lag in the impact of monetary policy. Some economists have suggested that the RBI’s timing is so badly off that its policy changes end up being procyclical.
In any case, the RBI has given a revised growth projection of 5.5 percent for 2009-10. This is a bit lower than government policy makers have been suggesting (more like 6 percent), but higher than some private forecasts, which are around 5 percent. This is still a narrow range, and a decent rate of growth. In that context, the comparative performance of India’s stock market over the last six months seems a bit puzzling. Here are four charts, comparing the Bombay stock exchange index with indices for Brazil, South Korea, China and Russia. Of these, only China is growing faster. Is it that the markets expect India’s future growth to be less than in these countries?
India vs. Brazil: 6 Months
India vs. S. Korea: 6 Months
India vs. China: 6 Months
It could be that foreign investors, who have influenced India’s and other emerging markets, are less bullish on India, or more uncertain. India remains the new kid on the block for many fund managers, so they may be slow to return to India in general. The current elections are also a major source of uncertainty. It is also possible that stock markets in these countries (especially India) do not always reflect overall growth prospects, since corporate profits are driven by a relatively small segment of the domestic economy, or by sector-specific international factors. I also wonder if the “India story” is not clear or well-developed enough for international fund managers, relative to those for other countries.
The two-year charts of relative market performance are also relevant. They show that India’s market has done better than China’s and Russia’s over this longer period. So the greater increase in those countries over the last six months partly reflects a steeper fall before that. However, the puzzle remains somewhat with respect to Brazil and South Korea, which have better stock market performance over the last two years, despite slower economic growth.
If India does recover relatively quickly, as officials and policymakers seem to believe, the stock market may be too pessimistic right now. The political uncertainty may also be less than it was a few weeks ago, as it looks like one of the two major parties will get enough seats to head a stable coalition without sacrificing the (admittedly gradualist) economic reform process.