Equity markets may cheer the BJP manifesto, but there is one big problem

The difference between an equity fund manager and a bond trader is that the former by nature is optimistic while the latter by nature is pessimistic and sceptical.

This is one of the reasons why the Sensex and Nifty are hovering at close to record highs in anticipation of a BJP-led NDA win in the 2014 general elections, while bond yields are trading at eight months highs.

The BJP manifesto clearly appeals to the equity fund manager. The emphasis is on growth, manufacturing, real estate and infrastructure. The bond trader will be wary of the manifesto as it does not address key issues of rising government debt, weak rupee and macro economic reforms for bringing down long-term inflation expectations.

Also, there is already talk of the new government confronting RBI governor Raghuram Rajan on the monetary policy stance.

In the long run, the bond trader is usually right as a distinct lack of appetite for government debt is a disaster for economies. Examples abound from the US in the 1970s to the eurozone countries in 2010, where rising government bond yields forced austerity leading to weak economies.

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Fortunately manifestos do not really work. The BJP-led NDA will be on the back foot from Day One to address problems of high cost of government borrowing and lack of resources for spending.

Equity markets may cheer the BJP manifesto but hard reality of the bond trader will force the markets to rethink short-term bullishness.

The opinion polls suggest that the BJP-led NDA, helmed by Narendra Modi will receive the majority votes to form a government at the Centre in elections 2014. The BJP released its poll manifesto yesterday and it is advisable to go through it if the party is going to run India for the next five years.

I searched for a few key words that could have encouraged me to believe that the new government is committed to macro economic reforms but I could not find them or find enough emphasis on them.

Subsidies was one, the rupee was the other, current account deficit was the third and corporate governance was the fourth. None of these words appeared in the manifesto. Fiscal deficit was mentioned once. There was no mention of government debt and interest costs on government debt.

Inflation was the first item on the agenda but the manifesto deals with inflation control by addressing supply of food that is primarily blamed for the high inflation in the country with the CPI (consumer price index) inflation averaging over 9 percent over the last five years.

There was no mention of subsidies, fiscal deficit and the weak rupee that is down over 30 percent over the last three years as factors affecting structural inflation.

Overlooking key structural macro economic factors is not an ideal way to control inflation in the long term.

The manifesto raises a few concerns on inflation. It aims to rationalise interest rates for the manufacturing sector to enable the sector to grow and create jobs. It does not mention how it will rationalise rates, by reducing government bond supply to provide more funds to the private sector or by working with the RBI (if media reports are to be believed, this would be browbeating) to rationalise rates. The former is productive, but the latter is destructive and highly inflationary.

The manifesto says that there will be 100 new cities to accommodate the urban population. This sounds like China’s ghost cities where there is no economics behind it: ideal conditions of corruption, over lending and speculation.

Apart from these factors, the Manifesto tends to given something for everyone as one would expect from a poll Manifesto.

Arjun Parthasarathy is founder Investors are Idiots.com and INRBONDS.com. Follow him on twitter @arjunparthasara