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Globalisation is a dirty word in many circles and automatically associated with politically-loaded concepts like "hegemony", "cultural imperialism" and so on. Stripped off jargon and emotion, globalisation just means that capital and businesses operate across borders with fewer constraints. As globalisation has taken hold, an arbitraging effect has arisen, reducing the returns and increasing risks for transnational portfolio investors.
When John Templeton put his theories of cross-border investment into practice decades ago, he received high returns coupled to a high degree of safety. Templeton was systematically exploiting the fact that national economies had different cycles. For example, if the Dow Jones was trending down, the Nikkei might be up, and changes in German bonds yields did not affect Brazilian debt.
Globalisation has reduced the hedge factor. Most large economies are now closely coupled to each other and most currencies can be easily exchanged. While there are local effects in every economy, large changes in one national economy promptly lead to large changes in others. For example, Chinese exports depend on the US' gross domestic product (GDP) growth and low yen interest rates impact the euro-denominated debt exposure of Indian companies.
Portfolio investors automatically factor in these connections and hence, financial markets anticipate the likely impacts of economic changes across the world. And so, stock market returns across the world are much more closely correlated than they used to be.
India saw some of the negative effects of the correlation coming into play when the Budget was announced on February 28. It happened to be a week when the US was bracing for cuts in Federal spending, and it was also the end of the February derivative settlement.
As a result, there was an absence of foreign institutional investor (FII) liquidity and despite buying by domestic institutions, the initial reaction of the Indian stock market was extremely negative. The trend continued to be negative through the next few sessions.
Once FIIs came to terms with the implications of US Budget cuts, they started re-investing across the world again. The Dow Jones Industrial Averages (DJIA) hit three successive lifetime highs last week and that optimism has translated into a bounce in Indian indices again. The rupee has rallied against the dollar as well, as FII inflows have improved.
Stripped of the liquidity effects and the cross-border correlations, the Budget seems a so-so document. There's a degree of relief that expenditure on the entitlements and handouts have not been massively increased in an election year. Tax rates have also expanded moderately.
There also seems to be some effort towards fiscal consolidation, and we probably have globalisation to thank for that. If the current account deficit expands much more, the rating agencies would lower India's sovereign rating to below investment grade. In turn, that would lead to overseas investors stampeding for the exit, and perhaps cause a currency collapse. This would not improve the United Progressive Alliance's chances of being re-elected.
The nightmare scenario outlined above could still come to pass however, even if the Budget isn't populist in nature. The revenue assumptions are massively optimistic and will not be met unless there is a big bounce in GDP within the next six months.
There are absolutely no signs of such a bounce occurring and there are no obvious policy changes that would trigger such a reversal in sentiment. Perhaps one hope for an expedition of processes and legislations that speeds up all the infrastructure projects that are stuck in various stages of limbo. That would restore some levels of credibility to the Budgetary estimates on the revenue side.
Industrial activity did not pick up in the third quarter. This is obvious from both the Index of industrial production data and the quarterly reports of listed corporates. Judging from the corporate results, consumption slowed and profitability also stagnated across a broad selection of sectors. The number of restructuring requests from distressed borrowers has also hit record levels.
In the fourth quarter, we have the auto industry releasing overall February sales figures that are negative, and Maruti cutting back production in March because it is sitting on a month's inventory. Given the auto industry's long and complex value-chain and its employment-generation capabilities, and also given Maruti's market share, I'd be willing to bet that industrial activity did not pick up in the fourth quarter either.
We're back to hoping that the Reserve Bank of India (RBI) cuts policy rates to a substantial degree and that helps accelerate growth. Given the unabated levels of consumer inflation and even the overall levels of wholesale price inflation, the central bank is not likely to throw caution to the winds. Core inflation has indeed abated but food, housing, clothing and energy prices have not.
The market has already started to factor in a likely repo rate cut in the next monetary policy review (March 19). People will listen with rapt attention to D Subbarao's speech in the hopes of deciphering his future strategy. I suspect the optimists may be a little disappointed. If the RBI cuts at all (I think it will), it will cut repo by the minimal 25 basis points.
One cannot discount the FII effect, of course. It's perfectly possible that they will continue to be net positive on India. Post-correction and post-resurgence, India is ranked 39 (out of 51 markets), as it is up 1.3 per cent in calendar 2013. In comparative terms, that makes Indian equity look attractive for a contrarian.
On the technical side of things, the Nifty is now testing resistance at the key 5,950-5,975 zone. If it can climb past that, the rest of March will probably be positive. But don't forget to watch the DJIA charts as well - if US indices start correcting, so will the Indian markets.
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
