When problems are good

Markets expect the investment cycle to revive from the fourth quarter

In one of their interactions with institutional investors, the powers that be in the government have conveyed that reforms in India have never been gradual, they’ve always been opportunistic. In effect, what they mean to say is that India acts only when it’s pushed to the brink. This, probably, explains the reason why analysts keep comparing the 1991 balance of payments crisis with the current situation.

When pushed to the wall, the Indian polity is known to act. So, this time, analysts are celebrating India’s twin deficits, too. The smart strategists have been going long on India since June, as the government had made it clear it would act after the presidential elections are over. So, in the last one month, the outlook for the Indian markets has changed dramatically. The announcement of an unending round of quantitative easing by the US Federal Reserve only added fuel to an already fiery mood.

Deutsche Bank’s strategist Ajay Kapur believes it’s best to let the rating agencies worry about the deficits. “When the twin deficits are high, like now, something happens – policy reforms get enacted, while valuations already reflect the grim situation. Prospective returns from these diabolical twin deficit levels are exceptionally good,” he explains. So, the recent words of caution from Standard & Poor’s on Wednesday can only be good for Indian equities as it means more reforms, if this theory is correct.

While the government may face a legislative hurdle in pushing through measures like increased foreign direct investment (FDI) in retail, pension and insurance, the finance minister has conveyed that all will be done to revive the investment cycle. This will be more than a sentiment booster for the economy. If the National Investment Board is actually set up with over-riding powers on key projects, then it would boost the industry’s investment confidence. Also, if bottlenecks for 89 large projects are removed, then the investment cycle could turn by Q4 FY13.

Given the government’s focus on reforms, equity strategists are betting on some rate action from the central bank, too. JP Morgan says: “With the recent policy announcements, there is increased possibility of further cuts in benchmark rates over 2H FY12.”

Despite the euphoria on “reforms,” the market has no clarity on what to buy. While most analysts remain underweight on financials, there are those who believe that with rate cuts imminent, banks are a good bet. There are others still betting on sectors that would benefit from a weaker rupee, though the local currency has been on an uptrend.