THE UPSWING CONTINUES

E.C. Thomas *

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Foreign institutional investor flows into India are set to touch an all-time high with less than four months to go before the end of the calendar year 2003. This heightened foreign interest in India has restored local confidence in the market and channelled the ample domestic liquidity into equities. Set against the backdrop of low interest rates, low growth and deflation in the developed economies, the emerging markets like India offer exciting growth prospects. More importantly, having been out of favour for long, this asset class is available at very attractive valuations. Within the emerging markets, apart from a possible 6.5-7 per cent growth and improving corporate numbers, India has an added attraction in a stable or slowly appreciating currency. And the various controversies over outsourcing to India have only helped focus attention on India’s potential. As a result, India seems to be cornering a higher share of incremental investments in emerging markets.

The sharp rally in the market – the BSE Sensex has appreciated nearly 1,000 points since April 2003 – has taken care of the under-valuations. So the inflows may not be as strong in the remainder of the year as they have been over the last four months. The gradual inching up of interest rates in the US should also have an effect as arbitrage opportunities would stand reduced, resulting in lesser debt inflows. But that does not mean that the direction of the flow would be reversed. The fundamentals of the Indian economy appear very good and there is no reason why investors should have any rethink.

Confidence

There is a growing confidence that the Indian economy has acquired a momentum which is largely independent of political developments. Regardless of which formation is governing, the entrepreneurial energies of India’s talented population cannot be stifled any longer. Fund managers and analysts talk approvingly of India’s ‘fundamentals’ – about projections for economic growth ranging from 5.5 to 7 per cent growth for this fiscal, the burgeoning foreign exchange reserves, the bountiful monsoon, the increasing global competitiveness of Indian companies and the way they have ruthlessly pruned costs and enhanced bottom-lines. They are not just talking but also putting their money where it should go. In August alone foreign institutional investors pumped over $400 million. The net inflows since January stand at $ 3 billion.

It is also encouraging to note that the present rally is quite broad-based. A recent study showed that scrips of 225 companies have posted an all-time high during the current calendar year, while 2,382 companies have hit their 52-week highs in the past four months. This would seem to indicate that the market is not being rigged by a handful of speculators, as has happened in the past. Even so many retail investors with bad memories may be reluctant to re-enter and their caution is fully justified.

Though the pessimist may be right in feeling that the current rally is too good to last, a fact that cannot be dismissed offhand is that the fundamentals of the economy today are far better than what they were when the markets rallied in the past. While this may only partly explain the reasons for the current upward trend, it is also true that markets elsewhere, like the Dow, Nasdaq, Nikkie and those in Singapore and Thailand, have rallied on the optimism that the worst for the world economy is over and that it cannot go down any further.

Analysis

The ongoing rally in share prices has been interpreted in various, often contrary, ways. The first big question to which there has been no unanimous answer is: will the rise in the share prices – the benchmark share indices have climbed to a 30-month high – be more enduring this time than at any time in the recent past? On the one side are analysts who feel that the rally can be sustained. They cite strong and improving economic fundamentals as well as a vastly superior recent corporate performance. The external economy has been a bright spot. Reserves have grown to record levels. Foreign institutional investment continues unabated with the stock market being the major beneficiary.

The rupee has been strong and holding its own against major currencies. Inflation has been contained below five per cent. Following the satisfactory monsoon, the rural economy is poised for a major recovery, in turn boosting rural incomes and purchasing power. The GDP growth during the current year is expected to be in the region of 6.5 per cent, compared with last year’s 4.4 per cent. Corporate performance across major sectors has been impressive, the more so because the improvement is attributed to genuine productivity gains and not such fortuitous factors as the fall in interest rates.

Without disputing all this, the contrary view holds that a resilient economy and much better corporate results do not by themselves point to a long and sustained stock market rally. Too often in the recent past, a dramatic drop in share prices has followed an upsurge even if the latter had been fuelled by some positive economic or political news.

In India the correlation between economic news and share market prices has never been strong. To be euphoric when the markets look up and utterly despondent when they fall is an all too common tendency. This has often prevented policymakers from taking a sober stance towards the capital market. Basic issues such as the desirability of extending bank finance to the stock market or delineating an appropriate role for traditional intermediaries such as brokers remain controversial. Capital market regulation too has suffered. Regulators have been criticized for not being proactive and detecting scams early enough. That has made them take extraordinarily defensive positions.

Growth

The tidings on overall economic growth this fiscal are very positive, according to the authoritative assessment of the Reserve Bank of India. Thanks to a good monsoon, the Central Bank has indicated in its latest annual report for 2002-03 that its earlier projection of 6 per cent GDP growth might be "exceeded significantly". This optimistic prognosis is based on a strong rebound in agricultural growth expected this fiscal together with a healthy industrial performance so far. While this is the good news, there are questions on the sustainability of this growth performance.

The last time we grew at over 6 per cent was in 1999-2000 when we just tipped the scale at 6.1 per cent. The intervening three years have seen the economy hobble along at an average rate of about 4.7 per cent. An increase to ‘significantly’ over 6 per cent is, therefore, about the most welcome news we have had in a long, long time. Ironically, on the very same day that the RBI released its report, the IMF (in its draft World Economic Outlook) cut its global growth forecast even as it raised its forecast for India, albeit marginally from 5.1 to 5.3 per cent. Clearly, not everyone shares the RBI’s bullishness on our growth prospects.

While there are a number of positives – diversified industrial recovery, rising business confidence, strong forex reserve position, healthy growth in exports, comfortable food stocks and buoyant capital flows – there are many areas of concern as well. The prime among these is the state of the government’s finances. Fiscal adjustment is sorely needed. Today revenue expenditure accounts for nearly 85 per cent of the Centre’s aggregate expenditure, leaving only 15 per cent for investment. This must change. Lack of proper infrastructure is a major obstacle to faster growth. However, given the composition of government expenditure, it is very difficult to cut back on such expenses. The key to both fiscal improvement as well as better infrastructure will, according to the RBI, have to hinge on improved revenue collections.

Meanwhile, with good economic news flowing in from various quarters, the Government has made bold to post India’s economic data on the website of the International Monetary Fund (IMF). Posting of economic and financial data on the IMF website is expected to provide the potential foreign investors and those wanting to trade with India to assess the country’s economic health and also make a comparison with the data from other countries. There are 53 other select countries which have posted their data on the IMF page. (PIB Features)

*Senior Journalist