The stockmarket greeted the election results with unbelievable ecstasy, and the market hit two upper circuits within minutes, resulting in a gain of 17.3% in a day! The sensex ended up an astronomical 2110 points and the Nifty was up 651 points during the few seconds the market was open before hitting the two circuits. It digested some of these gains and slipped 241 points on the sensex and 48 on the Nifty.
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Very interestingly, the FII's net purchase on Monday, when the sensex behaved like Sehwag on steroids, was just Rs 53 crores, whilst the domestic funds were net sellers of Rs 1 crore! The next day, when the market corrected a bit, FII's were net purchasers of Rs 5045 crores (over $ 1 billion) whilst the domestic funds were net sellers of Rs 1720 crores. This means that the upper circuits were hit on low volumes by virtue of change in sentiment, but not by volume as the markets were shut down.
The week ended with the BSE-Sensex up 1713, at 13887, the largest weekly gain ever. The NSE-Nifty was up 566, at 4238.
There is now a changed perception of India's future, thanks to the electoral mandate which has put in the hands of the Congress party the unencumbered reins of power. They now have no excuses for not carrying the baton of economic reforms forward, as they are not dependent on the fossilised ideology of their erstwhile coalition partners. The $1b investment by FIIs on Tuesday is testimony to expectations that the new Government would move ahead on economic reforms. What are those?
The first signs would be the allocation of portfolios. The biggest scourge of India is the corruption that prevents the benefits of even socially relevant schemes like the National Rural Employment Guarantee scheme, from reaching the beneficiaries. One of the coalition partners, the DMK, is demanding more cabinet berths (to accommodate a son and a daughter), or threatening not to join the Government, a demand that has so far been resisted.
The next finance minister (likely to be Pranab Mukherjee, because of his political acumen, rather than the one the market would be happier with, Montek Singh Ahluwalia) would need to contain the fiscal deficit which has spiralled way out of control, without sacrificing growth. There is too little time to present a Budget, so a second 'vote on account' can be expected pending the budget. This would only ensure that there is enough money in the kitty to pay the salaries of Government employees, so would not contain any major provisions.
The Finance minister may need to raise some taxes but, in order to keep the economic growth up, would do better to curtail expenditure. One of the biggest items of expenditure, and the one that needs change, is on petroleum product subsidies. These basically subsidise car and truck owners by reducing the cost of petrol and diesel, respectively, and are paid for by the three oil marketing companies (IOC, HPCL and BPCL, all of them are bathed in red ink because of it, a destruction of their 'navratna' status) and by ONGC, OIL and GAIL. ONGC and GAIL have minority investors who can file a suit against the Government for oppression of minorities.
The subsidy, moreover, encourages the growth of private transport. Look at the state of the US auto industry; one manufacturer, Chrysler, has filed for bankruptcy protection and another, GM, is set to. We are building up an infrastructure that would need to be junked perhaps 20 years later. Instead, why not use the resources frittered on petro products subsidies, to build up efficient public transportation systems? If there is movement towards such steps, there would be cause for investor jubilation, since reforms would be on track.
Then there are reforms in agriculture which are necessary. Agriculture supports over 60% of the population but gets only 18% of national income. This is manifestly unfair. Terms of trade for agriculture would have to improve in its favour, so that farmers get a fairer share of income. Until productivity gains kick in, this would imply higher produce prices, something that politicians tend to decry for fear of its impact on inflation. The political urban bias would need to change. This should be followed by a series of policy measures designed to improve productivity, so that prices can be lowered and yet farmers get a higher share of income.
One of the crying needs is rural connectivity, and more would need to be spent on better roads, so that the 35% wastage in transport of fruits and vegetables is avoided. Laws that restrict movement of agricultural produce would need to be amended, to give them a fair price. Steps such as these would point to economic reforms being on track.
Industry, which contributes some 28% of national income, has been asking for a more flexible labour law framework. Counter intuitively, this will actually help job creation rather than job destruction. Promoters would, knowing that they could shut failed businesses after proper compensation, be more willing to start new projects. Industry finds ways, such as hiring contract labour, or outsourcing bits of work, to beat inflexible labour laws, but it would be far more sensible to do it the straight way. Movement on making labour laws less inflexible, would indicate a Government on track.
Investors would also be looking at the steps taken to reduce the cost of money. Basically this would mean reforms in banking, insurance and pension sectors. Public sector banks still have 70% of the banking assets. During the global financial crisis, this has been a good thing for India, because PSU banks concentrated on lending, rather than investing which those banks who got into trouble, ended up doing more of. Having said that, the cost of intermediation remains high, with spreads of 2.5- 3% being rather common.
The pension funds have to be allowed to grow, in order to provide long term funding for corporates. Indian companies with global ambitions had access to funding and some have overpaid for the acquisitions. They are finding it difficult to roll over the borrowed money. Tata Motors had to raise Rs 1250 crores from LIC, via a 7 year, 10% non convertible debenture issue. This situation is because most of the PSU banks have exhausted their exposure limits and, despite having funds, are unable to lend to it. JSW Steel is having to shut down the US plants it acquired, for want of demand. Companies like Unitech and Indiabulls Real Estate have had to make equity issues to QIPs.
The rally is because of great expectations during these hard times. One hopes the new Government would meet those expectations so that investors wouldn't need to say 'what the dickens!'