The shadow dance between the finance ministry and the financial markets has been fascinating to watch.
Illustration: Jayachandran / Mint
Stock market investors started off this episode. They bought equities with almost blind joy on 16 May, when the results of the Lok Sabha elections were announced. The stock market had to be temporarily shut as a wave of buying pushed up the Sensex by 1,950 points in a matter of seconds.
The relief that India would not have a ragtag coalition government generated part of this euphoria. And then there was the hope that a United Progressive Alliance freed from the clutches of the Left would usher in big-bang reforms. Then, it all went into reverse gear. The Union Budget presented by finance minister Pranab Mukherjee disappointed the equity and bond markets. The former were shocked to see no big reform announcements. The latter were rattled when the government said it would need to borrow a record Rs4.51 trillion from the financial system in this fiscal year to bridge its huge fiscal and revenue deficits. Prices of equities and bonds plummeted.
That is when the finance ministry seems to have gone into damage control mode. The initial dismissive tone was replaced with a more conciliatory tone. It was first clarified that maybe half the government deficit would be “supported” by the Reserve Bank of India (RBI). Economists are still debating whether this means the central bank will be forced to print money and thus fan inflation down the line. The finance ministry has responded with confusing assertions that open market operations—a tool that RBI uses to manage liquidity in the economy—do not constitute back-door monetization.
Then, various ministries started hinting that disinvestments would start very soon— a signal that reforms are not on the back burner. The markets perked up.
The stock market was enticed by the potential opportunity to buy good public sector companies. The bond markets were relieved that higher equity sales by the government would mean lower bond sales. Meanwhile, the markets also lapped up statements on how financial sector reforms would soon be back on track.
Part of this is distressing and part is puzzling. The stock market’s unthinking lurches are the distressing part of the story. The puzzling part is why a government could not have dropped stronger reformist hints in the Budget as well as clarified that part of the fiscal deficit would be monetized.
Is clarity of purpose all that difficult to convey?
Are the government’s disinvestment plans an afterthought? Tell us at firstname.lastname@example.org