Weak commodity prices a big positive

Ironically, at a time when the economic slowdown is becoming entrenched, India is witnessing classic signs of overheating like sticky inflation and high CAD

In June 2012, I had said markets had turned excessively pessimistic and it was time to buy equities as well as long bonds. I expected this for the following reasons: Flushed with excess liquidity, global investors will pour money, given the relative attractiveness of India, and the government will be forced to get its act together due to the threat of a sovereign rating downgrade. Both, equity and bond markets have done well, since.

Recently, there has been a spate of negative news, including the Cyprus crisis, DMK pulling out of the government, a sting operation against some private banks, top telecom companies getting dragged into the 2G scam and so on and so forth. Mid-and small-cap stocks have been getting hammered, as selling by domestic institutions driven by retail redemptions continues.

All engines of economic growth are losing steam, growth in fixed investments has been declining since 2008 and, now, even private consumption is decelerating. Ironically, at a time when the economic slowdown is becoming entrenched, India is witnessing classic signs of overheating like sticky inflation, high current account deficit (CAD), sharp decline in savings rate and rising property prices.

But macros have their own self-correcting mechanisms. Also, the very fact that we are in a crisis, the likelihood of government responding sensibly is higher. Fiscal profligacy without any efforts to augment the supply side has been the crux of our macro problems. Credible efforts are now being made for fiscal correction. While this will curb consumption, it will help bring down inflation, the CAD and improve savings. The next leg of growth revival has to come from higher fixed asset investments and not from consumption. More than policy reforms, the execution logjam needs to be cleared. The Cabinet Committee on Investment (CCI) could push through existing projects in oil exploration, power, roads and railways (the big ones like DMFC and DMIC). I also expect incremental savings to get channelised towards financial assets as real rates turn positive and relative attractiveness of real estate and gold fades. Application of the Prevention of Money Laundering Act (PMLA) on these asset classes will help. The Reserve Bank of India (RBI) has cut interest rates by 100 basis points and further easing of 50-75 bps could be expected next year.

I think, the next wave of global merger and acquisition (M&A) boom will positively impact several sectors in the country. I expect global commodity prices to remain soft due to demand destruction, which a big positive for India's macro. The CAD is looking scary but just like inflation and the index of industrial production (IIP), incrementally, it will show improvement. Currency depreciation benefits are yet to accrue. Even in a scenario of 'no reforms' in Delhi, I expect growth to bottom out at five per cent given India's structural drivers and focus on development by state chief ministers. An early election might lead to the market buying a call option on possibility of an "icon of reforms and governance" becoming the next Prime Minister (remember the "panic buying" rally of May 2009).

Indian entrepreneurs and investors are perturbed over the happenings in the last five years, while ignoring the vast potential that lies ahead. The rearview mirror shows an ugly picture, but markets are all about 'change in perception'. Remember, cycles are getting shorter and a bull market may actually be underway, while improvement 'on the ground' and 'in the numbers' may be round the corner. Global investors have been more optimistic on India. It is time, domestic investors repose their faith.

The author is chief investment officer, SBI Mutual Fund