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Fundamentals will rule - Views on News from Equitymaster
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  • Feb 3, 1997

    Fundamentals will rule

    Contrary to popular belief, the bull rally is beginning. Keeping in mind the 50% chance I have of being right, I am still sticking to my earlier view that the 4,000 level is achievable by budget day.

    Let's recapitulate on what has happened since November, 1996. By the first week of December, 1996 every sattawalla in the country and every FII and every analyst and every newspaper writer was convinced that the market was heading to the 2,200 level. But that didn't happen. The market - prompted by statements and promises from more senior sattawallas in New Delhi - reversed direction very sharply and zoomed up to hit the level of 3,800 by January, 1997 before closing the month at 3,382 - still up some 20% in two months from its December bashing.

    All right, the senior sattawallas in New Delhi made some wild statements which gave the market the jet propulsion northward movement for the past two months. But like most elements of hot air, this one too has proven to be like the leaking rocket fuel that has caused many a crash on NASA's launching pads. Yet, rightly or wrongly, SEBI inquiry against misleading statements or not, the bulls have won because the market has been moved to a higher plane on pure local, speculative money. Not even a fraction of the 20% rise in share prices that has taken place to date is due to any UTI money or any FII money or any local investors' money. In the past 60 days, the reflating in the BSE-30 Index is only due to a speculative assault on the baffled computer screens.

    In the past 60 days while every newspaper headline has zeroed in on the speculative element of the rise in the BSE-30 Index, no one is writing about or talking about the quiet change that is taking place in the Indian economy. Anecdotal evidence suggests that institutions like ICICI and IDBI are begging corporates to take money from them. This confirms the trend towards a previous prediction that the increase in money supply has been so rapid and so sudden that interest rates will have to decline substantially and that corporates, starved of funds six months ago, will be offered cash every day.

    Think about it. You are ICICI, IDBI, or State Bank of India. Your deposits or borrowings have increased and you are paying anything between 10% and 17% on that incremental increase in your money base. The call rate is anything between 0.5% and 8%. For how long are you going to keep the money in the call market where it is a guaranteed losing proposition for you? For how long will you only chase the big corporates that do not need your money? For how long can you resist lending to Mr. medium size company who is desperate for your money? When will your fear of having a potential NPA be less than your fear of facing the fact that you are losing money every day by playing it safe and putting the money on call. For how long can you hide under your table and forget the fact that you are a banker and your job is to lend money, not hoard it? That a banker's job is to quantify risk and price it accordingly and not fear risk and stop doing business?

    And around this time, the money in rural India from a better monsoon should be finding its way into the real economy. Farmers should be buying their TVs, clothes, scooters, houses, just about now and adding to sales and accelerating inventory depletion. All of this will boost corporate performance.

    Is politics holding back the market? What can be worse than a 13-party coalition government? Do you expect a 14-party coalition government in the next election? Do you expect any government to walk in and say no more subsidies to agriculture or exporters? Do you expect any government to come in and say India is up for sale? The reality is that many subsidies are going to stay. Neither Rajiv Gandhi's 350 member Parliament brigade could change that and neither could Manmohan Singh's IMF-inspired 1991 budget. Subsidies are a fact of life in most nations in some form or shape. Corruption at the level that goes on in India and the inability to punish the criminals are probably what sets us apart from many other nations. Those are valid reasons for being skeptical and seeing an Index of 2,200.

    But foreign institutional investors don't make judgments based on the corruption index. They make judgments based on turning points in the economy. And when the figures released over the next few weeks suggest a turn-around in the economy, they will come flocking in. Their buying will drive the Index from the 3,500 levels to the 4,000 levels. And they will buy on the expectations of a better performance from corporate India for the 12 months ending March 1998.

    The FIIs, who were following the views of research analysts, mis-judged the economic cycle completely in calendar year 1996. They ignored the economic fallout of rising interest rates and the inability of the Congress government to instruct the RBI to increase the printing of paper - an inflationary act that is not good stuff in an election year. They have been badly burned and will not buy into this stock market based on expectations. They will buy only on the back of proven fact. This time around will only come in when the numbers prove that the economy has turned the corner - they will buy more expensive but they will buy into more certainty.

    Fears of the government adopting a tighter monetary policy on the back of rising inflation is premature. Inflation is of academic interest for the time being as this government doesn't need to worry about a voluntary or mandatory election. If the 13-party coalition was to collapse tomorrow, many present members of Parliament would probably lose their deposits next time around. And a mandatory election is five years away. Mr. Gowda and Mr. Chidambaram want to go down in history as the men who take India on the 7% growth path - inflation is a by-product of that ambition. Mr. Manmohan Singh wanted to be known as the man who got India's inflation down to 5% - killing economic growth was the sacrificial lamb. That is the crucial difference between November 1994 and today.

    For all of calendar 1995 and 1996, the FIIs have misunderstood the impact of politics on the direction of economic growth. To be sure, the printing of money without any controls or norms is dangerous but let's give this government a chance to prove itself unworthy of doing any justice to the macro-economy and then let's vote for a party which we believe can deliver. But to damn the long term ability to solve a long term problem of deficits and to ignore an improvement in agricultural production with its resultant increase in economic activity and corporate profits is a bit like not buying a gas-guzzling sports car today for your enjoyment because the world will run out of petrol by the year 2020.

    The basic fact of a wealthier rural India and rapidly falling real interest rates (12% in July, 1996; 7% today; and maybe 4% by April, 1997) suggest that the economy is going to show signs of improvement and, if it does, can a 4,000 Index be that far away? Throw in a few inexpensive sops on FERA in the budget and that higher level may be there a bit sooner. The speculators have done their bit and have changed this animal called sentiment, the buyers of the fundamental story will do the rest.



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