Devangshu Datta: Markets down, but not out

The president of India could be a real power centre only in doomsday science fiction scenarios. He or she would take charge only if the Cabinet was wiped out by, say, a terrorist attack. But despite the absence of real power, presidential elections are an important signalling tool.

Installing a preferred candidate is a way for the ruling party, or coalition, to show it’s in control. For example, back in 1969, Mrs Gandhi senior demonstrated her ascendancy over the Kamaraj Syndicate by putting V V Giri in Rashtrapati Bhawan. Presidential elections are especially important for coalitions since the right person in charge may also be an enabling factor when the next general election comes around.

In the shorter term, the open breach caused by this issue between the Congress and the Trinamool Congress (TMC) may be important. Will a distancing from the TMC mean a greater willingness to take policy action?

The TMC has certainly been a retarding factor. History also suggests insecure governments, as in 1991-93 and 1999, are more prepared to take politically-risky measures. It raises other questions as well.

For example, who takes charge of Pranab-babu’s portfolio? Whoever takes over has his, or her, task cut out. The latest macro-economic data confirm that deceleration continues. The external situation is closer to a crisis point.

In that context, policy paralysis may no longer be a viable political stance. For one thing, the international investor community is on the verge of losing patience. Anybody who has worked in institutional finance is well aware of the reluctance to call a spade, a spade. Things need to be pretty bad before institutions use words like “policy paralysis” and “stagflation” in official communiques. We’ve seen such usages in conjunction with recent warnings about impending rating downgrades and GDP estimates from various institutions all the way below the official government projections.

The poor prognosis is backed by the latest data. India’s macro-economic data and data collection methods have long been considered dubious. There are endless rounds of revisions and massive changes in each revision. State-level data are a black hole. Reconciliation issues arise when export-import data doesn’t match estimates by trading partners. There are political sensitivities since inflation data are linked to dearness allowances and tax breaks.

But even if one discounts inbuilt inaccuracy, the data point in the same direction. The latest index of industrial production estimate of 0.1 per cent year-on-year growth in April and the wholesale price index estimate of 7.55 per cent inflation gel with the established trends of high inflation and low growth. So do the flat auto-industry sales numbers for May.

However, markets are eternally optimistic. If the European situation turns around, there could be a boost in global shareprices. If the Indian government shows signs of recovering from three years of policy paralysis, there may be a localised boost. In the meantime, palliative measures in next week’s credit policy could help to hold the line.

The Spanish bank bailout is actually of greater import than the Greek elections. Spain presents a conundrum — it has lower government debt as a percentage of GDP than most euro economies. But it also has a real estate and construction bubble that has gone bust. That has taken a large chunk of employment and most bank balance sheets down with it.

But it’ll take months before one knows if the bailout is working and the Greek elections happened on Sunday. In itself, Greece is an irrelevancy as a small, albeit badly mismanaged economy. However, the elections could trigger the exit of that nation from the euro currency union. And if Greece does exit, there will be some chaos that could trigger larger problems.

There could be wild fluctuations in the forex markets as the euro would swing unpredictably. There would also be a tendency to flee risky assets. A flight to safety would probably mean assets being transferred into USD and JPY bonds. A currency trader might be able to make a killing if he’s long USD-INR, long JPY-INR and short EUR-INR as and when, Greece returns to the drachma. On the other hand, if Greece does stabilise, the euro may harden temporarily.

Part of the impact on the rupee will depend on India’s monetary stance. Given the state of domestic affairs, you can make a case for either cutting or not cutting rates. Easier liquidity may help growth but it will also push inflation up.

However, the externals suggest cuts are necessary. The Reserve Bank of India’s (RBI’s) credit policy will be released before the Greece electoral results and implications thereof. China has recently cut rates — India should cut to stay at parity. And if the euro zone goes through disorder, India may need to cut by massive amounts to counterbalance. It’s questionable if RBI has the flexibility of attitude to deal with this.

The only guarantees in the coming week are higher volatility in forex rates, and higher volatility in rupee treasury and rupee equity markets. That means the Bank Nifty could bounce around a lot. Since the Bank Nifty is high-beta with respect to the Nifty and highly correlated as well, it will almost certainly set market direction. Any positions in the Bank Nifty futures or in specific banking and NBFC stock futures can be hedged through Nifty options.

The technical position reflects uncertainty. While institutions have been net positive in the last fortnight, they have also been low commitment in terms of volumes. The Nifty has hovered around its own 200-day moving average without developing a clear trend. Expect a sustained trend to develop only after several high-volatility, high-volume sessions in the coming week. If the market stays above the 200-day moving average till settlement, it’s doing well.