Why markets may love the new, improved Chidambaram

Finance Minister P Chidambaram is talking the right language, sending out the right signals and doing the right things and the markets are loving it.

The Sensex and Nifty are at 2012 highs, the Indian rupee is up over 5.5 percent from the lows of 2012 and Indian government bond yields are looking to trend down from levels of 8.15 percent on the 10-year benchmark bond. The FIIs are embracing the FM by putting more money into equities, with over $1 billion invested in September 2012 to date.

Are we seeing a new FM who is far removed from the one who floated oil bonds to absorb subsidies, who waived off farm loans, who urged the RBI to let loose FII flows into the country and who completely failed to see a market bubble build up on excessive leverage across the globe, especially US banks?

If yes, then it is right to be optimistic on the economy and the markets. If no, then the market euphoria is temporary and markets can fall anytime if there are no followup reforms. This column would rather pick the former than the latter on the hope that the FM has realised the value of stable fiscal policies, low inflation and strong economic fundamentals. A strong economy will automatically bring in FII flows that can be absorbed without creating asset price bubbles.

The diesel price hike and the rationalisation of the LPG subsidy are moves that address the core of the country’s economic problems. The FM is promising more fiscal reforms by end-October 2012 and such reforms will encourage the RBI to lower rates. The FM this time seems to be handling the RBI better by carrying out tough measures on the ground instead of just dictating policies - as was his wont in his last stint.

FDI in retail and aviation do not amount to path-breaking reform but it helps global investor sentiment. Retail and aviation have their own set of issues that require to be addressed domestically. Indian business houses have enough money, or have access to money, to pump money into retail, but the fiasco of once promising retail chains like the Future group, which overleveraged without any strategy to make profits, has deterred more investment into the sector.

Aviation is another sector with structural problems. Airlines do not have pricing power to pass on fuel prices and other costs to the consumer and this problem has to be addressed for any airline wanting to invest in the country.

The FM requires to do more on addressing structural issues than on encouraging investments in problematic sectors. The main issues include the losses of state electricity boards (SEBs) that are estimated at over Rs 2 lakh crore. This is a national problem and not a state-level one, as lending banks, which are primarily government-owned, are sitting on a potential heap of dud loans to SEBs. The consumer is also affected as he faces power shortage and higher prices while the power producer is affected as sales to SEBs are certain to lead to non-payment of dues.

The tax net needs to be widened to take up the Centre’s tax to GDP ratio, which has hovered around 10 percent levels for a long period of time. The FM has stated that he is addressing this issue and hopefully the GST (Goods and Services Tax) will be implemented soon.

There is a lot more to do for the FM if he really means business. He had a chance to do the right things in the 2004-08 period when he was FM but he did not do it. Now is the chance to set things right. The markets are giving him the thumbs up now but he has to work to keep that faith.

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