With the threat of a ratings downgrade now thwarted in the near term and the UPA finally showing its might in Parliament, the Sensex rallied to its highest level in 22 months amid record trading turnover today.
Just two days after rating agency Moody's kept India's rating outlook stable after both S&P and Fitch downgraded it to negative, investment bank Goldman Sachs today upgraded Indian equities to overweight, citing growth recovery and moderation in inflation going ahead.
The investment bank went a tad further and said that economic growth is likely to accelerate to 6.5 percent in 2013 backed by favourable external sector demand outlook and a pick-up in domestic reforms.
It has set an end-2013 end target for the Nifty at 6,600 points, a 14 percent increase.
This affirmation from the investment banks comes despite India's high fiscal deficit situation taking centre stage amid several corruption allegations against the government.
Perhaps, with the Parliament logjam finally coming to an end today after the government agreed to a vote on its decision to open up the retail sector to foreign players in India, market participants have reinforced their confidence in the market and the government.
This is more than evident from the fact that foreign institutional investors have remained bullish on India despite the lack of participation from retail investors. FIIs have bought close to $20 billion dollars this year even as domestic investors have remained bearish on the markets. This means that foreign funds that flowed to India have appreciated. If the macro environment worsens foreign investors may book profits.
With today’s gain, the Sensex has rallied over 600 points in the last couple of trading sessions.
However, the continuation of structural reforms is key to sustain this rally.
"While allowing FDI in retail, the Goods and Services Tax, the direct cash transfer of subsidies, and the dedicated freight corridor will help, we believe further reforms on fiscal consolidation, financial liberalization and infrastructure growth will be needed to sustain an improvement in trend growth, said Goldman Sachs in a report titled "India: An improving outlook" today.
Even though the government has agreed to a vote over FDI, passage of key bills like insurance, banking and pension is imperative to sustain investor faith in the economy and the government.
On Friday, the government will release the third quarter growth numbers, the expectations of which are considerably low given that GDP growth has been languishing at around 5.5 percent so far.
"The key factor that has led to the deceleration in GDP growth from above 8 percent levels to the last quarterly print of 5.5 percent is a near collapse in investments," Rohini Malkani, economist at Citi, wrote in a report.
The net result: Markets are still dependent on foreign funds to fuel the rally. Unless government shows its resolve to end the gridlock for good and convince domestic investors that it serious about implementing its big ticket reforms, the rally will only be a short-term phenomenon without proper fundamentals in place.