The recent terrorist attacks on key establishments in United States of America are unprecedented. The magnitude of damage too, is quite unprecedented. These attacks, in the short term, are bound to shift the focus of the US Government away from economic recovery. This in turn could have some impact on other countries. It is possible that expectations of a global economic recovery, in mid 2002, might have to be stretched a little bit. On the other hand, it is entirely possible that economic impact of this event may not be materially significant as is apprehended presently by some quarters. However, without doubt, political impact globally is expected to be significant.
What would be the impact on the Indian economy? India is relatively less likely to be impacted, given its large domestic economy, much like China. This is based on an assumption that no similar incidents happen in India. Clearly, impact on South East Asian economies will be relatively larger. Overall, chances are that economic impact in whichever part of the world, is likely to be short-term rather than long-term.
Outlook for Equity Markets
Our equity strategy continues to be that of bottom-up stock picking. Whatever businesses we were buying into before the happening of this event, we will continue to expand our positions in these stocks because valuations will become even more affordable. This is assuming that there is no fundamental impact on any businesses emanating from this event. It is conceivable that there could be some impact on Indian software businesses. Whether this will be material or lasting will be difficult to conjecture at this stage. Probably, it will be neither. Our stance is cautious and in small careful steps we will expand the portfolio positions that we like in any case. Our reasonable cash levels across all the equity funds should help us in so doing.
Outlook for Bond Markets
Firstly, the dollar could lose globally and is already over 1% down post-event against the yen and euro. There has been a shift into safer assets and bond markets worldwide are likely to gain due to the imminent shift from equity to fixed income markets. The Federal Reserve has promised contingency liquidity support and there are chances that the Fed could reduce the benchmark rates further to ease the strain on the already beleaguered US economy.
Secondly, the terrorist attack has already had a sentiment driven impact on the oil prices. It is still unclear where these attacks have originated from, but any significant retaliation by US could have a lasting impact on the oil prices. This could impact the rupee as oil forms nearly 30% of the total imports. The oil prices after rising 4$/barrel immediately after the attacks have subsequently declined by 2$ as OPEC has stated that it is committed to maintaining the supply and prices in the critical US$ 22-28 band.
Thirdly, the global economy could suffer as US recovery could get delayed further in the near term as economic activity takes a back seat to politics and international relations. Indian exports could also suffer as US accounts for nearly a quarter of our exports.
Fourthly, there is a risk of portfolio outflows as investors' worldwide shift to safe haven currencies and bonds. This could be adverse for capital flows.
Although some of these factors are negative from the currency market perspective, the dollar's weakness globally means that the rupee has adjusted in the REER terms. The RBI with over US$ 45 billion of forex reserves would not hesitate to use them in case of any panic in the currency markets.
Overall, the liquidity in the system continues to remain positive. The bond prices after falling by nearly 60-70 paise in the late evening have risen back by 40 paise. The rupee has remained stable at 47.44 levels. In the near term we do not see any cause of panic and would expect the bond market to stabilize at the current levels. However, we would continue to watch international developments closely and would exercise caution in our portfolio action.