Devangshu Datta: The spectre of politics

While traders will be busy guessing RBI and Fed policies, political risk could cause massive price volatility in the first half of 2014

In May 2012, several commentators including yours truly, pointed out that India was experiencing stagflation. Those conditions (high inflation, stagnating growth) had been prevalent by then for over a year. Six quarters down the line, the situation hasn't changed much.

The stagflation has worsened and only a statistical quirk prevents it being acknowledged as something closer to full-blown recession. The consumer price index (CPI) numbers for November suggest that consumer inflation is running at 11.25 per cent year-on-year. The wholesale price index (WPI) rose 7 per cent in October and it probably stayed around the same levels or rose in November (WPI November data are due on Monday).

Gross domestic product (GDP) growth indexed on the basis of the WPI is believed to have run at around 4.8 per cent between July-September 2013. The CPI is the normal inflation indicator in most national accounts. If nominal Indian GDP is re-indexed to the CPI, the economy's growth drops to near-zero. (SWING FACTORS)

If this adjustment to CPI versus GDP is made retrospectively, we would see that the Indian economy has either been in negative territory, or logging around 1 per cent growth for the past 11 quarters.

This assessment is backed by the anaemic performance of the Index of Industrial Production, which was negative for October. At the same time, trade data suggest exports in November slowed, from above double-digits between August and October, to around 6.5 per cent. So, there wasn't too much cheer on that front.

The manipulation and interpretation of economic data is more akin to an art than a science. Often, the data tell you little and conclusions are nuanced. However, the re-indexation of nominal GDP versus CPI offers a fairly logical explanation of voter dissatisfaction with the United Progressive Alliance (UPA). Assuming the consumer price index accurately reflects the consumption basket of the aam aadmi/aurat, the aforesaid aam aadmi has endured recession/stagflation for three years.

Anti-incumbency votes are natural in that situation. It will be difficult if not impossible to reverse the groundswell of anti-UPA sentiment in the space of five or six months. There is no point in telling the average consumer that "core inflation" stripped of energy and food items has come down since the aam aadmi has to pay for both energy and food on a daily basis.

The Q2 data did include a couple of small positive signals. There has been a little pickup in corporate performance. The number of companies delivering results that exceeded consensus outnumbered the ones that disappointed. Imports continue to compress as well. Exporters continued to do well, despite the deceleration of growth in November. Crude prices have remained more or less stable as the global commodity markets factors in the possible return of Iran.

In the absence of major growth signals, the Reserve Bank of India (RBI) will have to focus on inflation. Since Raghuram Rajan has taken charge, the central bank has scheduled its policy reviews for a day or so after the US Federal Open Market Committee concludes its policy meetings. This time, too, the RBI will take stock and apply course corrections on Thursday, while the Fed concludes its policy meetings on Wednesday (early morning Thursday Indian Standard Time).

Will the Fed produce a tapering schedule for its Quantitative Easing (QE) 3 programme ? If it does, will the taper be gradual or sharp? The consensus is, any taper will be gradual, launching cutbacks of $10-15 billion a month on the the current rate of QE balance sheet expansion at $85 billion a month. However, opinions on timelines for the start of tapering range from January to April.

An early taper would mean that global markets tank from next week onwards. No timeline, or a commitment to postpone, will be greeted by a relief rally. Based on India's macro-economic data and based on what the Fed says, the RBI will probably hike rates a little, or a lot.

Expectations for RBI policy action range from a 25-basis point hike in the repurchase (repo) rate to a 50 basis point hike in the repo. The bears expect a hike in the cash reserve ratio as well. The market will shrug off a 25-basis point hike, if other things are unchanged and it will celebrate if status quo is maintained.

On the policy front, the spectrum auctions in January could receive a muted response. There is still no clarity on key issues such as spectrum usage charges, spectrum trading norms and merger & acquisition norms. Bidding is likely to be cautious in the absence. The industry has seen too much in the way of policy inconsistency to be optimistic about sane decisions on such matters.

In the meantime, the logjam continues in Parliament. Standard & Poor's recently pointed out that an increased perception of political risk could lead to downgrades if the 2014 general elections produces a similar hung situation with fragile coalitions unable to get things done. That is not an unlikely situation. Despite the recent Assembly results, the Bharatiya Janata Party (BJP) is far from certain to get anywhere near a majority in a general election. The political risk will cause massive price-volatility through the first six months of 2014, at the very least.

In the nearer term, we could expect volatility through the next two weeks as well. Bulls pushed the market to an all-time high on Monday on the basis of the BJP's strong showing in Assembly elections. There have been four sessions of correction since.

Next week will be dominated by traders making guesses about the Fed and RBI policies. After that, we'll have the foreign institutional investors going into wind-down mode as their accounting year closes. I wouldn't be surprised if the Bank Nifty swings 10 per cent inside the next five sessions and the Nifty swings 10 per cent in the remaining weeks of the settlement. Your guess is as good as mine when it comes to direction.