The biggest risk currently faced by investors in Indian equities, bonds and currency is political risk.
Political risk exists in the form of worry on mid-term polls at the centre, a lack of sound fiscal policies, mismanagement of states, cases of scams and corruption and the media blowout of political issues.
Investing when political risk is high is tricky as short-term volatility could kill future investment appetite. Investors should learn to navigate political risk instead of not investing.
The ruling UPA government at the centre looks to be on shaky ground with several of its allies either going against them; the government itself is also losing political ground.
General elections are scheduled for 2014, but if there is a political shakeout, the polls could be advanced. The government has overshot its fiscal deficit for 2011-12 by 1.3 percent, and while it has budgeted for a lower fiscal deficit of 5.1 percent of GDP in 2012-13 against 5.9 percent of GDP in 2011-12, the lack of reforms on subsidies and taxes are telling.
Most state government finances are hugely mismanaged, and hurting sentiment amongst businesses as well as consumers. The power problems faced by states due to the deep losses of the state electricity board (Crisil estimates losses of Rs 1.80 lakh crore for 2011-12) highlights the mismanagement of states.
Scams and corruption are daily headline-grabbing affairs, with a new scandal emerging everyday. 2G scam trials, corruption cases in mining and other such cases are hurting market sentiment.
The media is also playing its part on the investors mind by highlighting all kinds of political risks to gain readers/viewers. High levels of media-created political risk unnerve investors.
How do you tackle political risk
Investors have two options in the face of political risk. One is to stay out of the market and the other is to navigate the risk.
Staying out of the market could mean missing good investment opportunities as markets may just overlook political risk when there is good global investment appetite for risk assets.
Navigating political risk is a better option as it helps investors make sound investment decisions in volatile markets leading to better returns when volatility stabilises.
Five investment rules for navigating political risks
One, political risk affects businesses that are impacted by government policies the most. Investors should stay away from sectors and stocks impacted by government policies.
Government policies affect government-owned businesses the most, as seen by examples of state-owned oil companies (the fuel subsidy burden borne by ONGC, for instance, or the lack of capital available for oil marketing companies due to inadequate and timely compensation by the government for subsidy losses).
PSU stocks are best avoided at times of high political risk.
Two, businesses that are involved in scams and corruption cases are best avoided, as the witch-hunting will go on for a long time. Bottom-fishing such stocks will not bear fruit.
Corporate governance should be the primary focus of investors when political risks rise due to unearthing of scams and corruption cases. Companies with the best corporate governance practices and possessing a good, clean image should be the investment choices.
Three, mismanagement of state finances hurt entities such as state electricity boards. Companies earning revenues from selling to state-run companies will suffer. Investors should avoid investing in stocks that have a high degree of dependence on the state for revenues.
Four, poor fiscal policies of the government affect interest rates negatively. High fiscal deficits add on to inflation, while high market borrowings leads to pressure on yields on government bonds.
Rising inflation and rising bond yields leads to high interest costs in the economy. Investors should lower their exposure to interest-rate sensitive stocks in times of fiscal stress.
Five, the threat of mid-term polls have a negative effect on the broad market. Market volatility rises as talks of mid-term polls surface or recede. Calibrating investments on worries of mid-term polls is difficult and will usually go wrong as it is not easy to predict the outcome of political games. Investors should focus on a wider range of fundamentals at times of poll risks rather than just the poll risk factor itself.
Similarly, political risks recede when there is a stable government or when the government is forced to implement unpleasant near-term policies for longer term gains. Investors should then look at revisiting investments that were avoided in times of high political risk.
Arjun Parthasarathy is the editor of www.investorsareidiots.com, a web site for investors.
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Updated Date: Dec 20, 2014 09:17:38 IST