Strong decoupling forces appearing in the economy

If one is keenly observing the economy for revival trends, the time has reached for being hopeful. Stock market in the country is witnessing strong upward trends over the last one month, raising hopes for a macroeconomic revival in the coming quarters. The Indian stock market was an underperformer in 2011 compared to its emerging market peers. But, 2012 tells an entirely different story. Major stock indices rallied by around 20% during the last couple of months.

                Stock market revival can be interpreted as a preceding trend for a macroeconomic revival in the economy.  A booming market is conducive for promoting investment by the corporate. Other factors like stable and low inflation accompanied by softened interest rate are necessary to percolate the financial market revival into the real economy.

                 An early sign of a macroeconomic recovery is not confined to the stock market. Declining inflation and continuing consumption demand of course adds to the positive sentiments.

                Perhaps the most positive outcome of these is the declining inflation trend. The figures are nearing to the comfort zone of the RBI. In effect, the inflation trend has strengthened expectations of interest rate cut by the RBI in the immediate future. Once interest rate is softened, investment demand may pick up, reviving overall growth rate in the economy.

                The positive development India is interesting amidst the persisting negative trends in the global economy. Signs of positive trends are not appearing either in Europe or in the US. The EU continues to live under the threat of a potential Greek default and its exit from the Euro-zone in the medium future.  Recession in the US and its continuing struggle with debt problem are still pouring its negative impact on the world economy. But, the worst signs are from China, where trade contraction and rising inflation figures are creating shock waves in those quarters which expected the exuberant Chinese economy will bail-out the recession hit world economy. Recession in the West may produce strong export contraction for China and Chinese import demand may also come down dragging the western economies further downwards.

                The immediate reason for revival trends in India is also external. Flooding of liquidity in the Western financial markets is a major reason. During the last month, the ECB has added liquidity into the Euro-zone markets. Similar events have occurred in the US as well. This liquidity expansion in the West is coming into the Indian equity market at huge size. Figures by SEBI shows that FIIs have made a net investment of US $ 5.3 billion in the Indian equity market during the last two months.

                The coexistence of recessionary trend in the global economy with traces of domestic economic recovery indicates that decoupling forces are emerging in the Indian economy.  Sound domestic fundamentals like strong domestic demand, prices and investment may enable the economy to break away from the recessing world economy in the immediate future. The present positive trends are decoupling factors and their strength and duration will be determined by the follow-up form the RBI and the government in the coming weeks.