Devangshu Datta: A buoyant mood that could turn sour

The market is back to being optimistic. A good monsoon, prospects of an early passage of the Goods and Services Tax Bill, along with low energy prices and a dovish Fed, will keep spirits up. But niggl

There's been an upsurge in optimism in the past fortnight and the market has shot up by over four per cent in the last 10 sessions. Investor confidence has returned. There is consensus that the Q4 results represent the end of a long cycle of lower profits and flat revenues. There is also hope that the monsoon will be super normal after two seasons of drought. There are also confident assertions by the government that it will soon guide the long-awaited Goods and Services Tax (GST) Bill through both Houses of Parliament.

In addition to the above, Morgan Stanley has recommended going "overweight" on India and HSBC is also positive. As a result, May was one of those rare months when both domestic institutions and foreign institutional investors (FII) were net positive on equity (although FIIs sold a lot of debt).

However, sentiment could turn sour quickly if expectations are not met. June is expected to be a deficient month in terms of rainfall because the monsoon is arriving late. Although this is expected, a late monsoon will lead to stretched nerves.

The American Federal Open Markets Committee (FOMC) meets in mid-June and there is a chance that it could make hawkish noises or even raise the USD policy rate. If it does so, we may see a sudden sell-off across global equity markets. Of course, if the FOMC is dovish, the rally may develop new legs.

There are concrete timelines for the passage of the GST Bill. If it doesn't pass by around September 2016, it will most likely not be passed at all during this Lok Sabha term. Implementation would be chaotic for at least one fiscal (maybe longer given the experiences in Europe, which has far more developed and well-indexed economies). In September, the Reserve Bank of India (RBI) governor's contract also expires. If Raghuram Rajan is not reappointed, there could be an adverse reaction.

Morgan Stanley's reasons for advocating going overweight is based on extrapolation of several trends. India's market valuation ratios are supposedly attractive, relative to its peer emerging markets. Morgan Stanley also believes that the corporate earnings pattern may turn positive in 2016-17 after a negative 2015-16. Indian earnings growth will also, according to it, see outperformance with respect to other emerging markets.

The macro-environment is also seen to be positive, with hopes of reform and no threat of deflation. The interest rate regime is expected to stay benign, with further cuts in policy rates. This last hope, lower interest rates, could be belied if inflation rises more than anticipated. The April inflation numbers indicated that the Wholesale Price Index was coming out of six quarters of negative change while the Consumer Price Index had risen to 5.4 per cent year-on-year.

Given the RBI's target of retail inflation at five per cent or less by January 2017, and its external obligations in terms of $34 billion worth of swaps that must be unwound or rolled over in October-December 2016, the central bank will err on the side of conservatism. It is unlikely to cut rates if it sees inflationary patterns, or fears currency pressures. If the Fed does raise rates for example, the RBI may have to defend the rupee.

Core inflation stripped of food and fuel is rising. Food inflation is strong and crude prices have recovered from lows of $26-27 per barrel to over $45. It is assumed the monsoon will help cool off food inflation and the ongoing tussle for market share between Saudi Arabia and Iran will keep crude prices under control.

Corporate results so far do seem to indicate some revenue growth and mildly increased profitability if we discount the performance of public sector banks (PSB). Taking banking into account, overall profits have declined by 15 per cent, compared to 2014-15 when corporate profits dropped by over 30 per cent.

Assuming PSBs did not exist is difficult, however, since over 70 per cent of credit comes from them. The clean-up there will mean at least two or three more quarters of pain and the government will have to first, find resources to recapitalise and second, learn to run banks along less ruinously profligate lines. As of now, net non-performing assets are in the region of Rs 3 lakh crore.

The overall market performance still seems to be patchy, however. The latest noises out of the government about disinvestment are also not reassuring. Nor is the postponement of spectrum auctions, and the long delay in the release of the new Civil Aviation Policy.

On the external front, trade statistics continue to look alarming. Exports have dropped for six quarters in a row. Imports have also dropped, of course, due to lower energy prices. But if energy prices have now moved into an uptrend, as Citigroup and Goldman Sachs says, there will be pressure on the current account unless exports (and remittances from the hard-hit Gulf) pick up.

Technically speaking, we saw a breakout to well above the 8,000-mark in the last week. The market now seems to be firmly in bullish mode. A good monsoon, low energy prices and a dovish Fed would all help to accelerate the momentum.