Govt’s honeymoon period with mkts ends, reality check begins

By Pratigya Vajpayee

NEW DELHI: In financial markets, the first year of the Narendra Modi government would be remembered for the unprecedented capital flows, dizzying highs scaled by share indices, and a new, bulletproof image donned by the Indian rupee.

However, the fireworks should be viewed as a welcome that capital markets extended to a promising new regime, rather than applause for any work done by the government itself. Of course, much of the ovation was also for the slump in global crude oil prices, which gave India’s macroeconomic fundamentals a facelift, coincidentally in the same year.

Out of the various Indian asset classes, equities have had the most to benefit from the change of guard in New Delhi, as investors looked forward to the end of a stalemate on policymaking, often a feature of a pre-election year.

The carnival in the equity market began in September 2013 when Modi was named the Bharatiya Janata Party’s prime ministerial candidate for the Lok Sabha elections.

Later, BJP’s thumping mandate at the elections meant that the new government was equipped with the requisite political clout to push through key economic reforms, whose very discussion had made the United Progressive Alliance wobble.

The Nifty and the Sensex are up over 18% and 16%, respectively, since the 2014 election results were announced, and around 40% since September 2013.

The animal spirits were largely led by foreign portfolio investors, who have poured $31.5 bln into Indian equities since September 2013, of which $17.6 bln was May 2014 onwards.

What kept the overseas money streaming into the market all these months was the automatic improvement in macroeconomic fundamentals as global crude oil prices slipped over 20%.

With the drastic cut in India’s import bill, key economic variables such as inflation, balance of payments, and the government’s fiscal deficit all fell in line, egging on foreign investors to continue betting on the India story.

Loose monetary policies of major central banks across the globe meant that there was plenty of money flowing around, and it was no surprise that much of it made its way to India.

As far as the governance itself was concerned, there was not much basis for assessing the new regime, and investors were content as long as the government continued to send out the right signals.

The wakeup call came only in April, when the Income Tax Department slapped notices demanding 6 bln rupees as minimum alternate tax from foreign institutional investors. These investors had lost an appeal at the Authority for Advance Rulings against a levy of 20% minimum alternate tax on capital gains.

Between September 2013 and March 2015, the Nifty had gained over 70% to its record highs. However, since March, investors seem to have gotten more realistic and the euphoria gave way to ‘fundamental’ logic.

With earnings yet to see even a hint of recovery and most economic indicators not showing any positive trend consistently, Nifty has corrected more than 8% from its high of 9119.20 points in March.

The imbroglio over foreign portfolio investors subjected to minimum alternate tax further spooked overseas funds and equity investors.

Foreign investors have now sat up to take a long, hard look at the year that went by, and some have expressed their discontent about the pace of economic reforms in India.

“Cyclical macro parameters have improved sharply. However, corporate earnings remain weak, the investment environment is still lacklustre and the improvement in GDP growth has not been commensurate with the stimulus of low oil prices,” Barclays Research said in a report.

The uneasiness of foreign investors has also started manifesting in the form of outflows, which began in mid April, and continued into May. So far this month, foreign portfolio investors have net sold shares worth $876.22 mln, and seem set to make their biggest monthly net sale since August 2013.

Considering the massive scale of expectations that were pinned on Modi, the government did not really stand a strong chance to fulfil these in its very first year.

Even as it is too soon to pass the verdict on the Indian government’s ability and inclination towards economic reforms, one thing is certain that the honeymoon period is over.

Although the share market continues to entice foreign buyers at more attractive valuations, the scorching pace of inflows is unlikely to resume as investors worldwide are already overweight on Indian equities.

Unlike its first year in power, the government would have to earn the foreign inflows by ensuring a steady delivery of economic reforms.


It is ironical that on the day of the election results, government bonds ended in the red as the market dismissed Modi’s victory as an expected outcome. Only when foreign inflows came gushing in, did Indian debt markets realise the enormity of the mandate won by the BJP.

The year 2014 ended up being the first one since 2011 when foreign portfolio investments in debt exceeded that in equities, with a net inflow of$26.2 bln.

Since then, the 10-year benchmark government bond yield has declined around 100 basis points as the foreign demand bridged the demand-supply gap, while a sharp fall in inflation caused a downward turn of the interest rate cycle.

While much of the debt investment was in government securities, FIIs turned their attention to corporate bonds after running out of gilt investment limits in August.

When it was raining foreign portfolio investments, there is no way the Indian rupee could not have fallen behind.

The rupee is largely unchanged from its levels in September 2013, but is now widely acknowledged as a far more resilient currency than it was before. Over this period, the rupee has traded in a 58.34-64.27 per dollar band.

Although persistent intervention by the Reserve Bank of India in the foreign exchange market kept the rupee’s gains in check, the accretion to the central bank’s reserves gave the currency an image makeover.

Over the past one year, the RBI has added around $40 bln to its currency reserves, strengthening its ability to defend the currency in times of crisis.

Also, considering that a country’s currency is considered a mirror of its macroeconomic fundamentals, it is hardly a surprise that the rupee now shows a much prettier picture.

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