"The rupee is strengthening again," is what we think.

However, the truth remains that it is not the rupee that is strengthening but the US dollar which is losing its sheen against the major currencies of the world.

Given the weakening dollar, more FII money is being poured into India and the country is being looked at as a 'hot' destination for investment by major funds.

A majority of market players are so much in awe of the fact that FII inflows have remained strong that the fundamentals seem to be taking a back seat. At this juncture, we would like to focus on three major risks that can have a negative impact on Indian equities in the short term.

1. Inflation: The current WPI inflation stands at 7.3 per cent (for the week ended November 13, 2004), while the consumer price index inflation stands at 4.8 per cent as per the latest figures available. The large difference between the two shows that although input costs have increased, the same have not been passed on to the consumers by India Inc. This could be largely due to competitive pressure in the face of robust demand growth. This phenomenon is likely to result in a squeeze in the bottomline going forward. Further, rising inflation has also resulted in higher bond yields thereby resulting in lower other income, reducing further cushion for profitability.
   
   

   
   
   

2. Global impact: India's oil import bill surged by over 56 per cent during the first seven months of FY05. During the current fiscal, crude oil prices have increased by over 50 per cent while petroleum product prices in the domestic markets remained relatively unchanged. The recent surge of over 56 per cent in the import bill could be attributed to a rise in petroleum product prices to the extent of nearly 42 per cent while the balance is due to volume growth (see chart below). Given that the country imports nearly 70 per cent of its crude oil requirements, we are vulnerable to such spikes in crude prices. To put things in perspective, India is likely to emerge as the fastest oil consuming country in terms of percentage growth by the next fiscal while production remains stagnant.
   

   
   

3. Weakening greenback: Further, the weakening dollar is bringing in money into the country, which is likely to be short term, as once the Fed raises interest rates again (which is more likely), the India story might fade away and the current strength being witnessed on the back of strong FII inflows shall weaken. We therefore believe investors should have a cautious look at the markets currently.

We do believe that the long-term story looks positive. However, at the current juncture, we would rather advise investors to practice caution and not speculate!