Unjustified Optimism

The exuberance in the Indian fiscal markets has been a major side effect of the comprehensive UPA result in the general elections. The optimistic (and slightly hasty) FY10 growth revision (from 5.6% to 6.4%) has been an added incentive for investors, which is manifested in a 50% rise in the BSE 100 from December. The debate that now ensues between the optimists and pessimists is whether this rise in the stock market can actually be backed by strong fundamentals or is it yet another bubble in the making.


With the Left now out of the equation, and a leading reformer like Manmohan Singh at the helm, expectations on the reform front are high. More importantly there is a general assumption that promises stand a greater chance of delivery, particularly in the context of a roadmap toward governance via the establishment of new monitoring mechanisms (to monitor NREGS & flagship programs and report on their status publicly) and strengthening of existing mechanisms (Right to Information). These proposals will undoubtedly help enhance efficiency, transparency, as well as quality by subjecting schemes to public scrutiny and national debate, but we must also sound a note of caution as the ability of the government to convert these words in to action still has to be tested. Further, while the Congress has managed to garner 200+ seats, it still requires the support of regional parties. Thus, with upcoming state assembly elections due later this year and early 2010, one can expect some resistance to reforms. Recent examples are that of DMK’s stance on disinvestment and Trinamool Congress on oil price decontrol.


Apart from the aforementioned political angle, there exist certain key economic issues which may act as a drag to the growth projections. These are as follows:


Fiscal Deficit


India’s difficult fiscal position due to the continuation of the fiscal stimulus into FY10 with a projected fiscal deficit of 5.5% for the central Government (interim
Budget estimates). In addition, the monetary easing by the RBI has made available to the Indian banking system fresh funds amounting to ~$80 bn (7% of GDP). Thus the combined fiscal and monetary stimulus is estimated at anywhere between 7-10% of GDP.


In light of these observations it would seem that the possibility of a fiscal correction in the future is high.


Limited Scope of Credit Revival


The level of benefit of the credit revival mechanisms to small and medium sized companies, relative to large corporations, has been limited. In the absence of a broad based recovery in disbursal, it is unlikely that there will be a sustained recovery in capex and hence in industrial production.


Foreign Capital


For most emerging economies, the dependence on the developed world is twofold: for exporting its goods and services and as a source of capital. India’s dependence is low on the former count but high on the latter. Foreign capital plays a substantial role in the Indian financial and corporate sector. The decline in foreign sources of capital to the Indian corporate sector, has only been partially offset by the domestic financial institutions, notably banks


Thus while a 6%+ growth may be on India’s radar in the future, it nevertheless stands out that some of the earlier growth drivers such as easy capital flow from abroad and liberal lending from banks etc. are missing at present. The unveiling of UPA’s first budget in July will be an acid test for the current buoyancy in the financial sector. Positivism based on a victory for a political party and its ‘plans’are not sufficient and any optimism in the markets must be coupled with strong fundamentals for sustained growth.


Saiyid Lamaan Hamid

[Image source:http://im.rediff.com/money/2008/jun/17slid6.jpg]