Cheer up: We need not be gloomier than the FIIs this time

There are two ways to look at India at present. One is the gloom, doom way that says India is finished and it’s status as one of the most vibrant economies is over. The other is the beginning of a new chapter in India where the country will work towards taking it up the growth path and retain its place as a vibrant democracy.

Investors, especially domestic investors, should go with the latter view as the country’s problems are being recognised even though actions are slow in coming.

The list of India’s woes is endless. Power outages affecting half the country and bringing activity to a grinding halt, fire on a train connecting two major metros, communal riots in the north-eastern part of the country, below normal monsoons, poor Olympic performance, high inflation and falling GDP growth. The RBI added to these woes by lowering growth forecasts and raising inflation forecasts in its policy review in July. Capital markets are weak with equities down, bond yields up and the currency down on a year on year basis.

One can easily write off India at this juncture as a country that showed potential but has failed to deliver. In all this gloom there are some who are still smiling and they are real estate speculators, hoarders of gold and corrupt politicians, businessmen and bureaucrats who have still not been caught by the law. Real estate prices are up despite lack of infrastructure, including power and water supply, while gold prices are up on the back of a weak currency.

The average Indian who is bearing the brunt of the country’s woes might not see any light ahead in the near future. However, foreign institutional investors ( FIIs) are seeing light ahead. The FIIs have invested over $12.5 billion in Indian debt and equities in the calendar year to date. FIIs do not have to invest in India unlike a Indian resident and the fact that they have chosen to invest in the country when everything is looking bleak suggests that they are expecting things to improve and markets to look up.

The FIIs could be wrong - as they have been wrong many times in the past. FII optimism on India alone should not determine where the country is heading in the future. India is definitely facing some rough times. The fiscal deficit is likely to exceed the budgeted deficit 5.1 percent of GDP due to a lowering of GDP growth forecast from 7.3 percent to 6.5 percent (RBI forecast). This is one of the challenges facing the country. The government does not have any room on the fiscal front to improve on the country’s infrastructure.

The RBI is worried on inflation, which is trending at over 7 percent levels and does not look as if it’s going to come down soon despite slowing economic growth. The RBI is not forcefully easing monetary policy to provide support to the economy.

What will bring India out of the mess? Clearly there is a need for hard policy actions such as reducing subsidies and passing on rising costs to the consumer. However, hard policy actions are not likely to be taken in a big bang approach to reforms. It will only be taken in baby steps given the current political intricacies of the government.

Sustained FII and FDI (foreign direct investment) flows into the country could help spur investment demand. Global risk appetite is low at present due to the sovereign debt crisis in the eurozone as seen by record low bond yields in the US, Japan and Germany. Investors are moving money into safe haven treasuries as a risk-aversion measure. It is unlikely that FII and FDI flows will happen in a flood.

It is difficult to pinpoint what will take India out of its present position. It will be a series of positives rather than one big action that will put a floor on the country’s fall and push it firmly back up. The positives include small steps on reforms, including partially freeing diesel and LPG prices, lower policy rates on signs of inflation coming off, corporate sector restructuring to become more profitable and global central banks providing continuous liquidity to markets.

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