The UPA's recent policy initiatives have enthused investors, but they won't settle for anything less than sustainable reforms
Two factors were preventing the Indian markets from breaking out: one, concerns regarding global economic conditions and, two, policy paralysis on the domestic front. Coincidentally, the clouds on both these fronts have lifted simultaneously.
Several factors support the view that the Indian market may be entering into a structural bull run. The immediate impetus for the markets came from the United Progressive Alliance (UPA) government's aggressive and proactive policies. When the government announced a rise in diesel prices and further liberalisation of foreign direct investment (FDI) in retail, it was feared that it would buckle under political pressure and roll back these measures. Its resolve, despite the risk to its survival, has enthused market participants. Moreover, these don't appear to be sporadic reforms: the government seems to have a clear road map to pull the economy out of its current rut.
The private sector's disinclination to undertake investments has been a key issue plaguing the economy. The government's initiatives, such as power sector reforms, have instilled confidence among companies. The recent news of a consortium of banks (including SBI and HDFC) agreeing to lend $7 billion to Tata Steel and $2 billion to Hindalco hints at a revival in capex.
On the political front, too, the picture has improved. The exit of a disruptive ally like the Trinamool Congress may actually be a blessing for the government's reforms programme. The Samajwadi Party's track record so far has been less obstructionist vis-a-vis reforms.
Liquidity inflows have been exceptionally strong this calendar year. So far this year foreign institutional investors (FIIs) have invested around Rs 82,300 crore in the Indian markets. With central banks around the world undertaking monetary easing – the European Central Bank (ECB), the US Federal Reserve and the Bank of Japan have all announced bond buyback programmes – liquidity inflows are likely to continue.
A rate cut by the Reserve Bank of India (RBI) in its monetary policy review at the end of October could be the icing on the cake for markets. When the RBI had cut the repo rate by 50 basis points in April, it had said it expected supportive action from the government in the form of a reduction in fiscal deficit. September's mid-quarter policy review came too soon after the government announced the hike in diesel prices. But by October-end the RBI may be more amenable to a rate cut.
The disinvestment plans have the potential to revive the moribund primary markets. There is adequate liquidity waiting on the sidelines to absorb these issues. However, they must be priced right. Only then will they create wealth for the investor and have a positive impact on the secondary impact (the positive fallout from the Coal India issue is an example).
A possible negative for the markets could be disappointing September-quarter results or disruptive political developments. In my view, while a few corporations may fail to meet expectations, the overall results are unlikely to be so poor as to prove a dampener.
The festering European crisis does pose a risk. However, the ECB's assurance that it will take all possible measures to stem the crisis provides reassurance. China's slowdown may actually be a positive, because it could keep commodity prices soft.
If liquidity inflows continue and the government does not roll back its policy measures – and continues with more reforms – the Indian market could well revisit its previous peak, surely by the end of this financial year if not by the end of the calendar year.
During the long downturn retail investors appeared to be losing faith in equities, as is evident from the closure of 2.36 million folios of equity mutual funds so far this year. Sadly, this trend is not ebbing even though it is prudent for retail investors to at least maintain their asset allocation to equities even if they are reluctant to increase it.
As for sector calls, in the past risk aversion drove market participants towards defensive sectors like FMCG and pharma. Valuations of some FMCG companies have reached levels that appear hard to justify. Now, with the markets in risk-on mode, rate sensitivies such as banks, auto and infrastructure are likely to outperform. Those who already have money invested in the markets may rotate it gradually from defensive to rate-sensitive sectors.
Head – Private Client Group Research, Kotak Securities
"At current valuations, the markets are likely discounting most of the known positives. A secular bull run depends on further action from the govt and the RBI"
The markets witnessed an eventful September with positive news coming on both global and domestic fronts. Seasonally, September is usually considered a "down month", but for India, this was one of the best months in recent times. Indian benchmark indices gained about eight per cent during the month, with several mid-caps rising more sharply.
On the global front, stimulus measures from the European Central Bank (ECB) and the US Federal Reserve helped shore up business sentiment. This additional liquidity is expected to increase flows into various asset classes including emerging markets. The Fed will continue to buy mortgage-backed securities and undertake other asset purchases if the outlook for the labour market doesn't improve substantially. Expectations are also rife from China that the government may embark on a fresh stimulus programme to support the slowing economy. We note that the additional liquidity in Europe will be sterilised and will not flow into other asset classes. Also, the US Fed will buy mortgage securities for $40 billion monthly, and this figure is lower than earlier expectations.
On the domestic front, the government made a good start on the reforms initiatives by making multiple announcements. It has sought to reduce the subsidy burden by increasing diesel prices and limiting the availability of subsidised LPG per family. Apart from this, it has allowed foreign direct investment (FDI) in multi-brand retail, aviation, power exchanges and segments of broadcasting. The withholding tax on foreign borrowings has been reduced to five per cent from 20 per cent. The Rajiv Gandhi Equity Savings Scheme has also been formally approved.
The government has also approved the scheme for financial restructuring of state distribution companies (discoms). The scheme contains various measures required to be taken by state discoms and state governments to achieve the financial turnaround of the state discoms by restructuring their debt. The government has also announced its intention of setting up the National Investment Board (NIB). These initiatives are seen by the markets as a precursor to a softer interest rate regime. Foreign institutional investor (FII) inflows rose quite sharply during the month at about Rs 190 billion in the cash segment.
Over the past four months, benchmarks have risen about 18 per cent on expectations that the government will initiate the reforms process and the global liquidity will improve after further stimulus from the ECB and the Fed. To that extent, some action from the government and global central banks was already priced in by the markets.
Thus, we opine that more needs to be done for the economy to prosper and the markets to go up further. More initiatives to improve the investment climate are needed and will be welcome. The investment rate has come off in the past few quarters and needs to be improved. The slowdown in investments in manufacturing is adequately reflected in the near-flat growth of the index of industrial production (IIP) on a year-on-year basis. The capital goods sector has seen negative growth for several months recently. To that extent, the government needs to act on some core sector reforms. Any further progress in areas like land acquisition, mining, power (fuel linkages) and so on will improve investment sentiment among corporations. There are various hurdles that are restricting investments in manufacturing and related sectors.
The inflation rate in India increased slightly to 7.55 per cent in August 2012 from 6.87 per cent in July 2012. IIP for July also reported marginal growth of 0.06 per cent largely due to negative growth in capital goods. Though the Reserve Bank of India (RBI) reciprocated the recent reform measures by reducing the cash reserve ratio by 25 basis points, it fell short of cutting key policy rates due to persistent stickiness in inflation. Further action on core reforms will increase the flexibility with the RBI in dealing with interest rates.
At current valuations, the markets are likely discounting most of the known positives. However, further reforms expected in coming months might reverse the decelerating growth trend in GDP in FY14 and help sustain or improve the earnings growth and valuations going ahead. Thus, it is contingent upon further action from the government and correspondingly from the RBI whether the Indian markets go up in a secular bull run or not.