Is the ‘Modi Premium’ Wearing Off in the Stock Markets?

As Modi completes one year in office, a sense of despondency pervades the customary reviews that ritually accompany such an event. Rumblings of discontent have emerged from various stakeholders and stock markets have taken the lead in signalling disappointment with his performance.

As Prime Minister Narendra Modi completes one year in office, a sense of despondency pervades the customary reviews that ritually accompany such an event. Rumblings of discontent have emerged from various stakeholders, including Corporate India. But it is the stock markets that seem to have taken the lead in signalling disappointment with his performance.

The bellwether index S&P BSE Sensex, comprising 30 stocks, has witnessed a major erosion in values over the past few weeks. From its all-time peak of 29,681.77 points achieved on January 29, 2015, the Sensex hit a low of 26,599.11 on May 7: a sharp drop of 3082.66 points (or 10.38%) in slightly over three months.

The capital market’s rebuff is symbolic: it tries to aggregate what’s going on in different parts of the economy and transmits its sentiment through one single number. And going by its recent behaviour, there seems to be plenty that is wrong, or perceived to be wrong.

Foreign portfolio investors, an influential investor segment in the capital markets, are a visibly disgruntled lot and they have been letting off steam by selling en masse. In the first 10 trading days in May (till May 18), FPIs were net sellers to the extent of $2.306 billion. FPIs enjoy disproportionate influence over Indian capital markets, primarily because they bring larger volumes to bear than domestic institutions. Low retail participation in the capital markets — either directly or indirectly — also keeps Indian markets shallow.

Tax uncertainties

These FPIs decided to head for the exit because of continuing tax uncertainty. Finance minister Arun Jaitley’s 2015-16 Budget had unequivocally clarified that tax will not be levied on the capital gains of FPIs in the current year. But, unfortunately, there was no assurance that past cases won’t be re-assessed. And, true to form, tax authorities sent notices to various FPIs to pay up for past gains. That precipitated widespread resentment, with some FPIs even going to court and, of course, venting their spleen by selling Indian stocks.

The minister, presumably rattled by the exodus and the bad publicity all this was generating, has gone out of his way to placate FPIs. Apart from putting all reviews and fresh cases on hold, he resorted to the time-tested stalling tactic: he appointed a committee. In effect, he has kicked the can down the road and bought some time. This incident also illustrates how FPIs have emerged as a crucial constituency, with an uneven share-of-voice.

Unsatisfactory corporate results is the other reason why Sensex is volatile. Many companies — especially in the mid-cap segment — have reported disappointing results for 2014-15, signifying that demand for goods and services continues to remain weak. A report in Mint has highlighted how Q4FY15 sales of 142 companies included in BSE-500 (and for which results were available) has grown at the slowest pace in 16 quarters since Q1FY11.

This is evidence that the economy is still far from recovery. The Index for Industrial Production has grown by only 2.8% during 2014-15. Consumer durables manufacturing contracted by 12.5% during the year, compared with 2013-14, signifying the lack of purchasing power in the economy.

Matters have been made worse by the unseasonal rain in many parts of the country this year, destroying hectares of standing crop, which typically comes to the farm markets in April. This is likely to further dampen demand for consumer goods in the rural areas. The stock markets are also trying to capture this trend.

Oil prices fall opportunity lost

One can argue that this is sheer bad luck and the government cannot be held responsible for this catastrophe. While that is true, it is also a fact that the government didn’t rush to reap the dividends of fortuitously low oil prices when it came to power. Since then oil prices have climbed 50%, spooked by the continuing West Asian crisis and some shale oil wells in USA shutting down.

There could be another charitable explanation for the unusually turbulent Sensex: that expectations from PM Modi might have raced way ahead of reality, especially after the depressing paralysis that gripped the economy in UPA-II’s second term. The common beef (pun intended) is that even the current BJP-led government has plumped for incrementalism, rather than bold policy measures they had promised.

There are two sides to this debate and both can be deemed valid. But, what is undeniably true is that the stock market has already started discounting PM Modi’s premium, even before he completes a full year in office. And, though the Sensex is still up 14.78% from where it was a year ago — it closed at 27,687 on May 18, 2015, compared with 24,121.74 on May 16, 2014 — it seems that market participants have already watered down their expectations and moderated their hopes about a magical, almost fantastical, turn-around in the economy.

Courtesy:

Published first in The Wire (http://thewire.in/2015/05/19/is-the-modi-premium-wearing-off-in-the-stock-markets/) on May 19,

and then subsequently reprinted in 

Gateway House (http://www.gatewayhouse.in/is-the-modi-premium-wearing-off-in-the-stock-markets/) on same day.

Sir, Your Talk Time's Over...

Prime Minister Manmohan Singh, on June 6, announced a long list of projects that, when completed, can be expected to rejuvenate the economy's mojo. The markets -- already enthused by Reserve Bank deputy governor Subir Gokarn’s statement on rate cuts -- took heart from PM’s statements. In an economy devoid of any feel-good news and wracked by a steady stream of depressing developments (low GDP growth, a resurgent inflation rate, depreciating rupee, corruption, policy inaction), these two events were welcomed quite like the delayed monsoon clouds.

But it is primarily the PM’s statement that provides some hope to many beleaguered market operators. In short, the PM has proposed investments of over Rs 100,000 crore in various infrastructure projects across various sectors – such as, roads, power generation, coal, ports, aviation and railways. Read the full press release here and here.

The plan sounds grand and has all the right ingredients to lift the economy out of its current slough.

But -- and sorry to sound like a wet blanket -- market operators seem to be in for a big disappointment. What’s wrong with what has been announced? Technically, nothing. The economy needs large doses of investment at this juncture to pull it out of the morass and the recent declaration seems to fit the bill. But, such announcements have been made even in the past. Like earlier occasions, this time too, the government has trotted out only a large string of impressive numbers, but has failed to mention a couple of crucial facts.

Point One: Who, in the name of blazing heavens, has this kind of money today to invest in infrastructure projects? The government is already highly leveraged and is liable to get tripped by the market if it tries to borrow over and above its budgeted expenditure. The only way it can free up some cash is by cutting down on some items of non-plan expenditure, such as wasteful subsidies. But, as everybody knows, that is still a long shot. Even the private sector is hamstrung, with profits falling for FY12 and the continuing slowdown spooking all investment plans.

The only option left is overseas funding. But, the government needs to use the broom vigorously to clean up multiple acts before a single cent rolls in. For instance, there needs to be a serious rethink on external debt ceilings if the private sector is expected to pitch in with funds and expertise. Second, the government might need to use innovative structures to fund such projects without impacting the overall deficit numbers. (One can read ICICI Bank chairman K V Kamath’s interview for some ideas).

Point Two: Time to repeat the point that was made earlier. Such announcements have been often made in the past but without any follow-up on the achievements. In this case too, there seems to be no clues on how the government proposes to achieve these targets.

There are numerous reasons for the proverbial slip. For one, ministers handling the infrastructure portfolios are not schoolchildren in thrall to the headmaster or employees beholden to an autocratic boss. So, it really doesn’t matter whether they perform or not. These ministers are where they are because of other reasons. They have been elected to power and are holding a particular economic portfolio at the behest of the party chief and not the PM. Or, they are in the cabinet because they are part of the ruling coalition and helped UPA-II to stay on in power. Look at the empirical stuff: barring the ones facing criminal proceedings, not a single minister has been penalised for poor performance. Some have been merely shuffled off from one “lucrative” ministry to another.

Also, as has been seen on numerous occasions in the past, large projects are usually dogged by several problems: clearances, approvals, financial closure, regulatory hurdles. Add to that another malaise affecting most projects in India: the pay-off syndrome. Most large projects in India need to make pay-offs at multiple levels – at the central level, at the state and at the local municipality level. This adds to costs and, in many cases, renders the projects unviable. Inability to pay at any one level can delay the project irretrievably.

Do we have any word from the PM on how he’s going to block these malpractices? Nope. Any clues on how he proposes to give that all-important push to the projects? An investment tracking system has been set up (read here). Will that be that enough? As the cliché goes, only time will tell.

So, finally, how do we approach such announcements? I’d say hold the celebrations.