While equity markets across the globe have had an emphatic run off late, if one were to view the picture for the entire year 2004, not all things have been ripe.
Consider for example the after-effects of the Iraq war, rising crude prices, high inflation and rising interest rates. While the latter three seem to have a link, there were several other factors that led to high levels of volatility in global equities during the mid-2004 period.
What happened in 2004?
At the beginning of 2004, the global economic situation seemed brighter than it was a year ago (2003). Recovery in growth of world trade in 2003 was followed by a widespread optimism of acceleration in the same in 2004.
However, concerns persisted with regard to large disparities in the strength of domestic demand among the major industrial countries (largely from the Southeast Asian region) and increasing trade imbalances between the major economic blocks (read, the US).
A part of the same came true towards the second half of the year with the global benchmark currency, the US dollar, weighed under the pressure of a huge US current account deficit, depreciated rapidly against major global currencies (the Indian rupee included).
Factors like sharp increase in crude, commodity prices and uncertainty about their future development also cast pressure on the global equity markets, though not as much as anticipated.
The increase in commodity prices and the consequent rise in inflation sounded alarm bells for a large number of central banks worldwide. Among the first to react were the Bank of England, the Reserve Bank of Australia and the US Federal Reserve, the latter having raised its overnight rates by quarter of a percent each four times during the year.
The rates now stand at 2 per cent, with the latest raise coming just recently. The inflationary pressure is, however, not peculiar to the US economy alone. Rising commodity and crude prices had cast inflationary pressure on India as well, which has somewhat softened off late. In this regard, the RBI has also cleared its stance by raising key rates like the CRR and repo rate.
Some more causes for concern!
Despite witnessing a rapid growth (mainly export-led) in recent times, the developing nations of East and South Asia (excluding India) have been so 'engrossed' in being the manufacturing hub for the developed world (read again, the US) with all their low cost offerings that they have almost failed to give heed to a more fundamental factor of growth - the internal demand.
As a result, countries like South Korea are currently facing the threat of deflation, as the demand for industrial goods has failed to pick up in the economy. On the contrary, the highly indebted and saving short US consumer is facing the double threat of rising inflation and consequent rise in borrowing costs.
What makes the US situation grave is the fact that the world economy depends to a very large extent on the US consumer demand. And if they reduce consumption (or over-consumption!), export-led economic growth of the developing regions might take a hit.
At the same time, some economists do believe that US requires significant investment in capacity expansion and that the economy is steadily on the path to recovery.
Is this the beginning of India's century?
While the abovementioned factors had repercussions on the Indian markets as well, there were a few other factors that played their part. One, the general elections held in May brought in a new coalition (UPA) much against the expectations of the incumbent coalition (NDA) and a large majority of the populace.
While the markets had not yet recovered from this 'shock', the Left's comments against disinvestment let hell break loose on Black Monday (May 17), when the Sensex crashed nearly 11%.
However, the Union Budget that followed and the fact that the new government seemed to be carrying on with the reform process brought cheers back to the investing community, and more so to the FIIs who have bought incessantly into Indian equities. The latest count for net FII inflows into Indian equity markets was over US$ 8.5 bn!
Apart from the abovementioned factor (continuity of the reforms process), another fact that helped the cause of Indian markets was the relative insulation of the Indian economy from slowdown in China.
So, what next?
While the above factors make a case of India to be emerging as a more prominent player in the global economy, a lot of other things have to fall in place. Bureaucratic hurdles need to be lessened (if not removed) and the institutional framework needs to be strengthened.
Also, the fiscal mess (high fiscal and revenue deficit) needs to be cleared, as that would leave a lot more resource to be spent towards growth and development of the populace. If the present government, and the one to follow, is able to make progress in these areas, this century could indeed turn out to be India's!
While a greater integration with the global economy and financial markets will continue to affect India's economic progress going forward, investors need to consider the changing population mix in the country.
The rising middle class and a greater proportion of the younger population can act as a huge consumer base in the future and this can act as a hedge against increased volatility due to deepening integration with the world economy.
But whether the government will be able to create jobs for this rising younger population remains to be seen!
Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.
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