Indian markets to remain volatile ahead of F&O expiry; Iraq tension to weigh

The ongoing tension in Iraq weighed heavy on Indian stock markets last week. This week, too, uncertainty surrounding oil prices will dictate the trend on local bourses.

The stock market this week is likely to remain volatile ahead of the expiry of June futures and options (F&O) contract on Thursday. The rupee's movement as well as the progress of the monsoon would also affect the market. Though the monsoon may not have a major impact on inflation this year following a bumper crop last year, it will certainly impact market sentiment.

Inflation remains a key risk to India's growth. The rise in rail freight fares by 6.5 per cent will add to the woes as the higher prices will be passed on to the end user. If the tension in Iraq continues for long then it would add further trouble for India. Iraq has the fourth-largest oil reserves in the world. It produces 3.3 million barrels of oil a day, making it the second-largest producer in the Organization of the Petroleum Exporting Countries (OPEC).

Internationally, crude oil prices have risen to a nine-month high. Rising crude oil prices would mean higher import bill, a widening current account deficit, impact on foreign exchange reserves as well as a depreciating currency. This would restrict the Reserve Bank of India (RBI) from cutting interest rates. Already, high inflation has left little room for the RBI to cut rates. Rising oil prices will also put further pressure on inflation.

Due to high inflation, especially of food, the Indian government as well as the RBI have been unable to focus on growth. Neglecting inflation for achieving growth can have negative repercussions. The good news is that a high base effect may bring down inflation in coming months. Also, the minimum support prices of crops have been a key reason for the rising food inflation and, historically, during a bad monsoon, the MSP has come down and so has food inflation.

Moreover, with the US unlikely to increase rates in the next 10 to 12 months, the RBI will have some breathing space. Last week, the US Federal Reserve cut bond purchases for the fifth straight time. This time it cut purchases by $10 billion to $35 billion. The improved economic activity in the US has seen the Fed going as per plan in its tapering, and if it continues then the quantitative easing programme will come to a close by the end of the year.

Stock markets in India are also waiting for the Union Budget to provide the next trigger. It would make sense to wait for the budget, which is slated to be announced in the second week of July. Though the market is valuing and viewing India with a long-term horizon, one can't turn a blind eye to near-term hiccups like below-normal monsoon, rising oil prices and its impact on currency movements and inflation. The future course will be decided by the budget and investors should then make investment decisions accordingly.