Politics over economics

In the next six months, the investor focus will be less on corporate earnings and more on the likely outcomes of domestic politics and global geopolitics. There is little one can say about domestic politics beyond the fact that it's likely to get more populist, and there’s greater possibility of communal violence and other disruptions as the election draws nearer.  

On the global front, the US president will be more inclined to make irrational decisions as the 17 different investigations into his business activities and possible campaign violations continue. Trump’s negotiations for funding a wall on the Mexico border has taken the US government into a shutdown. His whimsies could affect global trade — there is only a temporary truce in the trade war. It could lead to more swings in energy prices, depending on the Iran sanctions. It could result in an escalation of instability in Afghanistan and Syria as the US pulls out troops — the Syria pull out triggered the resignation of Jim Mattis.

Brexit with all its possible scenarios will impact global growth, one way or another, since the UK is a big economy and a global financial centre. The EU’s fortunes will clearly be affected and that will have knock on effects. For Indian business, a hard Brexit could mean relocations to other EU nations (probably Ireland) or a loss of access to EU. Some of Tata JLR’s problems are related to these concerns.  

Three big central bank decisions this month could reset monetary trends through 2019. The Federal Reserve hiked the USD policy rate again, though it lowered inflation and growth projections. The Fed will also continue with its quantitative tightening, reducing its balance sheet by not reinvesting proceeds as its bond portfolio matures. 

The European Central Bank will halt its quantitative easing programme in January but it will reinvest the proceeds as its portfolio matures. The net effect will be tightening hard currency liquidity. That could mean a reluctance to invest in risky assets for Euro and Dollar players.  

The Reserve Bank of India (RBI), meanwhile, intends to increase its open market operations (OMO), buying Rs 600 billion worth of bonds every month. This is similar to the EU’s quantitative easing programme in shape. But unlike Euro and USD, the rupee is not completely convertible. So while it should encourage risk taking behaviour, the safety net for rupee investors is less robust. Net  FPI selling of rupee assets could continue until the elections.  

The government desperately needs cash and government borrowing will suck up much of the extra liquidity imparted by the OMO and leave a liquidity deficit. Spending is up, GST collections are running 40 per cent below estimates and may fall further with the latest rationalisation plans, and there are commitments to bank recapitalisation as well as to populist schemes such as loan waivers. 

The government is also looking at more options to raise funding via disinvestment. Apart from the PFC-REC deal,  there are IPOs of the twin railway subsidiaries, and follow on offers in PSU ETFs. There may be an interim dividend from the RBI, or not, depending on whether you believe the economic affairs secretary or the finance minister. There will almost certainly, be an attempt to tap the RBI accumulated reserves. 

The rupee’s fortunes will be tied to energy prices. Crude has seesawed in the last fortnight since nobody has a clear picture of supply or demand. Opec and non-opec exporters (namely, Russia) may cut supply more than anticipated. But demand could fall if global growth slows. US shale miners put a ceiling on prices because they can rapidly ramp up production. They also put a floor on prices because shale extraction is expensive and production drop if prices drop. That is a further swing factor. Add in other uncertainties and rupee volatility is a given. Opec may revisit its current policy and ask members to cut production by even more,  if it thinks there’s over supply.  

The new bank recapitalisation plans could be a band aid that enables lending by PSU banks during a key period when populist schemes have to be funded. Unconfirmed reports of possible fraud out of the Infrastructure Leasing & Financial Services (IL&FS) audit suggests things are even worse than previously believed and that means more nervousness about the NBFC sector.  

Retail commitments to equity held up through November, going by mutual fund inflows. The rebound of smallcaps and mid-caps to three month highs in December suggests domestic sentiment remains strong. If the OMO works, it should reduce yields in the bond market and that will mean stocks can sustain higher valuations as well.  

The equity market has seesawed in December. There is a disconnect between the Nifty/Sensex and small caps with 2018 returns ranging from nominally positive for Nifty to deeply negative for smallcaps. The BSE 500 is likely to deliver the worst return in many years.

The Nifty is range trading 10,400-11,000 and a breakout or breakdown could move it by 5 per cent in a very short time period. Historically, pre-election trading trends have been negative.  But there’s always a pick up in sentiment once a new government is in place, no matter the composition.  


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