Home >Opinion >Markets say they trust, but would like to verify

The stock market, that alleged repository of the collective wisdom of people, has not been doing much in recent months. The MSCI India equity index has inched up a mere 1.8% in the last three months, lower than MSCI Asia’s 4%, or the MSCI Emerging Markets index, up 3.16%. Some of the sheen has come off the Indian market.

Both the Sensex and the Nifty are lower than their closing prices on 9 June. Around a fifth of the stocks in the BSE 100 are now at levels lower than what they were on 16 May, the day the election results were declared.

Has the euphoria about the election results faded from the markets, to be replaced by a more hard-headed assessment? Murmurs and head-shakings about the new government have become more common in business circles. It started with the President’s address to Parliament, where the more impatient among the new government’s votaries were expecting to see the new CEO’s vision statement. The flip-flop over the increase in suburban railway fares and the rather glaring announcement of over 50 new trains in a speech that otherwise dwelt chiefly on the lack of money did not help. The budget suffered from the curse of incrementalism, not expected from a government with a mandate as robust as the present one. The extension of price control in the pharmaceutical industry did not impress business.

And now we have the scuttling of the World Trade Organization deal, with only Cuba, Bolivia and Venezuela in our corner. The vast majority of economists have said we need to end producer subsidies and replace them with consumption subsidies for the poor and the WTO has no limits on consumer subsidies. Agricultural experts have long pointed out the market distortion, inefficiency, waste and benefits to large farmers in a handful of states by the present system of farm subsidies. And yet, when it came to the crunch, the government preferred to wreck a deal rather than take the opportunity to change its subsidy system.

Does Narendra Modi’s election promise to farmers about support prices being fixed 50% higher than the cost of production—dismissed by reformists as one of those things leaders have to say during elections—have something to do with this? True, these are very early days and the government has been making the right noises, but surely it doesn’t take much time to announce an increase in cooking oil prices by a nominal amount every month in order to reduce subsidies on it?

Moreover, the tepid performance of the markets has come at a time when there are signs of the economy having turned the corner. Industrial production has improved while inflation has been coming down. Much of the deficiency in monsoon rainfall has been made up. The price of crude oil and other commodities is low. Companies have started raising funds to repair their balance sheets. The latest purchasing managers’ survey in manufacturing indicates a revival in output as well as new orders, and although input prices have gone up, output prices have not, which shows a lack of pricing power and suggests that core inflation is likely to remain benign. Real interest rates are now positive.

Yet market strategists have remained optimistic, for several reasons. Markets do not move in a straight line and it’s good for them to take a breather before the next climb. After all, MSCI India is already up 18.75% this year. Research has shown that if the market is up before a budget, it has a good chance of falling after it.

To be sure, India is now a favourite among global emerging market investors, which limits the scope for gains. At the same time, though, investors are still only marginally overweight on emerging markets, so India could benefit as money rotates back to them. With interest rates so low in the West, sentiment, which is often just another name for the weight of money, continues to be upbeat. Also, as a more recent Morgan Stanley note says, the Indian market is “still below peak multiples at what may be the start of an earnings upgrade cycle".

The more important reason, though, is the market continues to repose its trust in Modi, in spite of the disappointments mentioned above. There are myriad reports of government offices in New Delhi buzzing with activity. There are several anecdotes about swifter decision-making and better inter-ministerial co-coordination. That should result in starting stalled projects, giving a quick jump in growth. The push being given to infrastructure spending and to real estate should also help. The government has responded with alacrity to rising food prices. It has kept an ambitious fiscal deficit target, although nobody would have minded some relaxation. The hope is the Bharatiya Janata Party is waiting to win the next round of state elections before giving a big push to reforms. Some are even willing to wait till the next budget.

Nevertheless, there are some disquieting reports. One of them talks of the opposition by the Rashtriya Swayamsevak Sangh to genetically modified crops, labour law reforms and changes to the land acquisition rules. But for new investment, amending the draconian land acquisitions rules is a must. How will all those smart cities be built, without amending the land acquisition law? And for improving productivity, amendment of the labour laws, too, is necessary.

The market believes that Modi will ultimately deliver the big-bang reforms and it’s a work in progress. But there are indications of a nuanced shift in sentiment. In its recent note, Morgan Stanley says its approach to India is “trust, but verify". That’s a big change from the post-election euphoria.

Manas Chakravarty looks at trends and issues in the financial markets.

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