Devangshu Datta: When ennui creeps into the system

Twenty months after the Narendra Modi government was sworn in, stock market indices are trading at pretty much the same levels they hit in May 2014. The last month has seen multiple trillions wiped off the world's bourses. The last fortnight was utterly catastrophic. There was a small, sharp recovery on Friday but that might have been largely due to short covering. The European Central Bank and the People's Bank of China are, however, trying to stage-manage a recovery.

The first 10 months of the Bharatiya Janata Party-led government saw the stock market soaring to unprecedented levels, driven by a great deal of optimism. Most of the India-specific hopes now seem to have evaporated and investors have pulled out in droves, as the global economy has got worse.

At present, India looks like just another emerging market, albeit a big one, growing at a reasonable clip. Its fortunes are tied to China, the global commodity cycle and currency fluctuations. In corporate terms, one could say the management team, that is, the Indian Cabinet, has not been able to provide leadership of a quality that enables the country to pull ahead of its peers.

Legislative reforms have, in all probability, failed. There is no goods and services tax in sight; land reforms are off the agenda and labour reform has not been bruited at the central level. Trade has collapsed - exports, including non-petroleum-based exports - have declined for the last 14 months, even as countries like Bangladesh and Vietnam have been able to gain share in global trade.

There has been much controversy over the new methodology of gross domestic product calculation but there is also consensus that there hasn't been much acceleration in growth. The Index of Industrial Production suggests some growth in October and November, if we club the months together to adjust for fluctuations in output caused by Diwali-Dussehra. However, the Purchasing Managers' Index for December suggests manufacturing contracted in December even though services continued to grow.

Inflation appears to be under control, mainly due to low energy fuel prices. The Consumer Price Index (CPI) is under the Reserve Bank of India's (RBI) targeted rate of six per cent for December 2015 and the Wholesale Price Index is in negative territory, where it has been for 14 months. But the CPI is rising. Differentials between the two inflations make it hard to judge what policy decisions would be optimal. There have been grumblings about the spike in food prices, which has pushed up retail inflation.

Corporate earnings seem to have remained flat in the third quarter (Q3). Structural worries about banking and its smorgasbord of bad debt are cause for worry. Nominal growth is low (due to low inflation) and that makes debt servicing harder. Corporate investment also seems to have declined in Q3.

What is the government likely to do in the next Budget? This is an academic question since most of the Budget has already been done and dusted. But there are hard structural decisions to take. Will the Budget dump fiscal prudence and pump prime, hoping that the extra investment will help India grow out of the current recessive conditions? Or will it use low crude prices to tighten up subsidies and cut the fiscal deficit? One could argue for and against either action. But the last two Budgets - admittedly, only one was full-year, the other encompassed three quarters - were uninspiring and there are no guarantees that this government will make the right calls, whatever those are.

Foreign institutional investors (FII) have been selling equity in massive quantities although they have started buying rupee debt again. Domestic institutions have done a lot of buying but retail support for the market has also collapsed in the past fortnight. The FII attitude is likely to be dictated by market instability and the slowdown in China. If China is perceived to have stabilised, money will flow back into most emerging markets, including India.

The RBI's policy decisions in February are likely to be driven by currency considerations as much as by inflation. The rupee has weakened considerably versus the US dollar in the past month. In comparative terms, it may have strengthened versus the yen and the yuan. Where does the central bank want the rupee to go, especially in a scenario where the yuan is falling? My guess is, the RBI will maintain status quo in February and cut rates after the Budget.

In terms of valuations, it is hard to justify a market where the major indices are trading at an average PE of 20, and earnings are growing at six to seven per cent. So, there is plenty of room for the correction to continue, even though the Nifty is down 19 per cent from its peak in March 2015.

In technical terms, we might be entering a situation of reflexivity where a trend persists long beyond the target point. The downtrend has so far tested support at 7,240-7,250 and that support has held. The bounce on Friday looked more like short covering than valued-based investment buying. Further falls cannot be ruled out. Balanced against that, there may be some optimism about the Budget.

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