Despite tame Budget, investors should bet smart on Indian markets

Investors should look forward to more positive sentiments in markets given that this time around the conditions for a market rally are different. They should be choosy about their investments. On a thumb rule basis, investors should bet on strong USD driving equities higher but keeping commodities flat (as commodities are priced in USD and big economies of the world including China are expected to grow below trend rates). The earlier bull run where investors closed their eyes and bought everything under the sun (and ended up with burnt fingers) will not happen this time around.

The government showed its weak hand in the Budget 2012, where the only positive was that there were not many negatives. The budget reflected the government’s ineptitude in carrying out much-needed reforms in subsidies and taxes; and after a miserable year where all macro factors were negative, the lack of any positive surprise in the budget came as a rude shock to beleaguered investors.

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[caption id=“attachment_237802” align=“alignleft” width=“380” caption=“The economy is poised to improve - despite the government. Reuters”]  [/caption]

Indian investors have never had it so bad in a while. Equities, bonds and currencies have performed poorly since late 2007 and early 2008. The Sensex is 10 percent below levels seen in late 2007 while the Rupee is down over 15 percent in the four-year period. Bond yields have not moved much from their levels of 8.4 percent on the ten-year benchmark bond in 2007. Investors are in no mood to embrace markets that have performed poorly and with a government that has shown no signs of moving forward.

To be sure if one looks at the country’s macro fundamentals, one cannot get any confidence. GDP growth is down from 8.4 percent to 6.9 percent over the last one year, while inflation has trended at over 9 percent levels for the major part of calendar 2011. Fiscal deficit is higher by 1.3 percentage points over the budgeted estimates for 2011-12 while the current account deficit is higher by 1 percentage point over the last one year.

The government has not done anything concrete in taking up growth or bringing down inflation. It has raised taxes to improve revenues, but apart from that one cannot see any kind of action to improve the country’s macro fundamentals.

Should investors write off equities, bonds and the currency? The answer is no. The economy and the markets can do well despite the government. As long as the government does not act irresponsibly by resorting to populist measures, which it has not do in this budget, the economy can get back its footing, which in turn could improve market sentiments.

There are signs of the economy coming back on track. The first sign is that inflation as measured by the WPI (Wholesale Price Index) is below 7 percent levels against 9 percent and above levels seen in 2011. Inflation has come off on the back of many factors including rate tightening by the RBI, which raised repo rates for thirteen consecutive times in 2010-11.

Inflation looks unlikely to go back to 9 percent and above levels unless there is an oil price shock or a sustained rise in food prices. Economic growth forecast at 7.6 percent for 2012-13 is below growth rates of 8.4 percent seen in the years 2009-10 and 2010-11 and well below 9 percent and above levels seen in the period 2005-2008. Demand-side inflation pressures are not apparent as seen in the growth rates.

The RBI has enough room to bring down policy rates to bring about economic growth and if inflation is not seen as a threat, rate cuts will start in April 2012.

The global economic outlook is encouraging. The US, the world’s largest economy, is seen coming along well with unemployment rates down from levels of 9.5 percent to levels of 8.3 percent over the last eight months. The US has added 1.2 million jobs over the last six months upto February 2012, the highest seen since 2006. The country is seeing innovation at its best with Apple becoming the top company in the world in terms of market capitalisation and likes of Facebook, Google and Amazon figuring as high cash generators. The US Dollar has strengthened by over 6 percent from the lows seen in 2011 on the back of signs of strength in the economy.

Europe and Japan are flooding the world with liquidity. The ECB (European Central Bank) has added 1 trillion eurointo the system over the past three months through its LTRO (Long Term Refinancing Operations) while the Bank of Japan has increased bond purchases by $130 billion in the face of a third-quarter recession in the economy. The euro and the yen have weakened by over 6 percent from highs seen against the US dollar. The liquidity infused by the central banks will help economies across the world.

India will benefit from a strengthening US economy as software services creates jobs while liquidity infused by central banks will find its way into the country both directly through portfolio flows and indirectly through more trade due to improving economic conditions across the globe.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com, a web site for investors.