Crime and punishment

Why is the market rewarding loose monetary policies of Japan but is unimpressed with India’s promise of fiscal discipline?

By Mohan Sule
A stock’s price is supposed to fully value its historical earning at any given point of time. Risk-averse pickers wait for correction to possess a long-desired scrip. The reversal in price could be due to company-specific hiccups. The counter could also slide on profit booking after a sharp run-up, deterioration in the health of the industry due to factors beyond the company’s control, or because of the broad market slide on muddied outlook for the economy. The small gains that the cautious investor makes through this incremental approach are blunted by limited opportunities. The other class of risk takers prefers to look ahead to load the portfolio. The appeal of a stock is based on growth potential, estimated through order backlog or completion of ongoing projects. Last year, Maruti Suzuki was beaten on worker unrest at its Manesar, Haryana, unit as the valuation assigned due to its bulging order book looked expensive in view of the imminent delays in delivery and cash flow. IT stocks swing to economic data from the US and the rupee movement, which dictate the flow, pricing and realisation of contracts. The market crashed even as the UPA I government was being formed in May 2004 as a partner indicated burial of the PSU divestment program, so vital for narrowing the fiscal deficit and easing pressure on interest rates. Most firms tend to be conservative in their guidance. However, many are unnecessarily optimistic. The reason could be to convince the market to assign premium pricing to aid in fund-raising.

The exuberance is more pronounced in a bull market. In a downtrend, the concern is the worst is still to come despite valuations that have already factored in the sluggish growth and liabilities on the balance sheet. Of late, the market seems to be going against logic. Take two recent instances. Equity investors hardly flinched when rating agencies downgraded the UK and Japan due to their unhealthy balance sheets: Britain’s debt-to-GDP ratio is nearly 90% and Japan’s fiscal deficit is expected to balloon to more than 10% of GDP in the current year. As against a conventional response, the Nikkei index surged to a new high. In contrast, the Indian stock market seemed unimpressed with the finance minister’s confidence of lowering fiscal deficit to 4.8% from 5.2% last fiscal and boosting growth to an impressive 6.5% from an anemic 5% estimated for the March 2013 year end. It remained flat in the month since the budget. If equities are supposed to be forward looking, Japan should have shed value and India experienced a renewed surge. There could be two explanations for this behavior. One, the market had already absorbed the two contrasting scenarios: growth pangs for Japan and a turnaround for India. Two, it was excited at the Bank of Japan’s aim to inject liquidity till inflation rose to 2%. On the other hand, the Indian finance minister had failed to spell out the roadmap to achieve his projections. PSU divestment had fallen short of the Rs 30000-crore target. There was expectation of renewed policy paralysis due to the election season.

Yet stocks had responded heartily to the increase in FDI cap to 51% in the retail sector and to 49% in aviation in spite of the formidable obstacles at the ground level and to the partial rollback of fuel subsidies despite the walkout of a key ally from the coalition government. On the surface, it would appear that the market is discriminating by ignoring Britain’s debt pileup and the danger to Japan’s health due to easy money policy. India’s promise of prudent fiscal policies, in contrast, is not getting a warm reception. The inescapable conclusion is that foreign investors are assigning higher discounting to growth and differentiating between good inflation (US and Japan) induced to expand the economy and bad inflation (India) due to supply bottlenecks that is stalling output. The message is that India has to undertake deep reforms. The glimmer of structural shakeup late 2012 did more to propel the market than balancesheet jugglery to bridge revenue shortfall. Selling shares of PSUs to a state-owned insurer can at best be described as cash transfer. Instead of drastically slashing market borrowings for welfare spending and subsidies that keep interest rates high, the budget has passed the buck to the conservative investors, who will face lower payout from debt mutual funds that had become attractive due to higher return because of the hike in dividend distribution tax (DDT) and from efficient companies making more than Rs 10-crore profit due to the increase in surcharge on DDT.