Indian markets and the promise of reform

February 4, 2013

What a difference a few months have made for Indian markets.

The rupee is 8 percent up from last summer’s record lows. Foreigners have ploughed $17 billion into Indian stocks and bonds since Sept 2012 and foreign ownership of Indian shares is at a record high 22.7 percent, Morgan Stanley reckons.  And all it has taken to change the mood has been the announcement of a few reforms (allowing foreign direct investment into retail, some fuel and rail price hikes and raising FDI limits in some sectors). A controversial double taxation law has been pushed back.  The government has sold some stakes in state-run companies (it offloaded 10 percent of Oil India last week, netting $585 million).  If the measures continue, the central bank may cut interest rates further.

Above all, there have been promises-a-plenty on fiscal consolidation.

The promises are not new. Only this time, investors appear to believe Finance Minister P. Chidambaram.

Chidambaram who was on a four-city roadshow to promote India to investors, pledged in a Reuters interview last week not to cross the “red line” of a 5.3 percent deficit for this year in the Feb 28 budget. Standard Chartered, one of the banks that organised Chidambaram’s roadshow, sent out a note entitled: “The finance minister means business”.

FM Chidambaram has gained market credibility on back of measures announced since Sept. 2012. ..if he follows through on these pledges….markets will have more reason to cheer.

So what can be expected if the budget does deliver the goods? Assuming global central banks continue to gush liquidity, the Indian stock rally might continue.  Indian stocks trade at 16 times forward earnings, slightly below their historical averages.  The rupee too should rise further. It has an implied yield of around 6 percent,  one of the highest in the world. And unlike many other emerging markets, India won’t be averse to some appreciation from current levels of around 53. 15 per dollar. According to Arvind Mayaram, head of economic affairs at India’s finance ministry:

Once you see fiscal consolidation start to happen, you will see the rupee strengthen further… the rupee at 52-53 (per dollar) is good. It will be still competitive but imports will become cheaper and inflation will moderate.

And what of India’s woeful infrastructure?  India’s pot-holed roads, power cuts and clogged-up ports will take years, if not decades, to fix. But the government does seem keen to deal with the problem. Mayaram, in London for a recent infrastructure roadshow, said in an interview that the government had fulfilled targets for  $500 billion infrastructure investments in the five years to 2012 and  half of this had come from the private sector. Another $1 trillion is planned by 2017, giving an annual  investment rate of around 38-40 percent of GDP, he said.

All that is good. But elections loom in 2014 and the ruling Congress is likely to pressure Chidambaram to be generous to voters.  UBS analyst Manik Narain says a lot of foreign cash has headed  to India recently on the promise of yield and the premise that the inflows will be welcome (unlike in many Asian and Latin American countries, where governments are increasingly fearful of hot money). But he says the peak could be close if reforms are not quickly deepened:

Given how much pressure the Congress is under, I find it surprising the market is trading with so much optimism.  The truth of the matter is that the reform steps India has taken are welcome but they are really only baby steps. A sliver of reform is making India look attractive.

 The ball, as Chidambaram has acknowledged, is firmly in the Indian government’s court.


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