Have the markets overreacted to PM's austerity appeal? Experts decode

Experts believe the markets, which were already nervous owing to the West Asia war, may have overreacted to PM Modi's appeal for austerity measures given the sharp fall seen in the last two days.

Prime Minister Modi's recent appeal for austerity measures could be a signal for likely policy measures in the coming weeks in case the US-Iran conflict continues, feel brokerages. However, they may have overreacted to the request given the sharp fall seen in the last two trading sessions, experts suggest.  Markets, said U R Bhat, co-founder & director, Alphaniti Fintech, seem to think that the situation now is as bad as the Covid times, which is not the case. Markets were already nervous in the backdrop of the West Asia war, and the statements have added fuel to the fire. They are paying more attention to it than it deserves.  “Imposing more gold duty will serve no purpose. The markets have overreacted to the development. As an investment strategy, one can wait for more clarity. All depends on how things play out in West Asia. The Nifty has strong support at 22,180 levels, which should hold,” he said.     PM’s austerity triggered a 1.5 per cent fall in the frontline indices on Monday, which continued to reel under losses on Tuesday as well, with the Sensex hitting an intraday low of at 75,121 levels before recovering some ground.  G Chokkalingam, founder and head of research at Equinomics Research, too, believes that the markets have taken the news harshly. “Such a reaction was not expected. Things are not as bad as they seem. While the measures, if any, were to be announced in the days ahead, the markets may at best see a knee-jerk reaction before clawing back,” he said. 

What to expect?

  That said, potential policy measures from the government in the weeks ahead, according to analysts at Nomura, could include disincentivizing non-essential imports like gold, tighter rules on outward remittances, a foreign currency deposit mobilization scheme and a hike in domestic fuel (petrol, diesel) prices.  Since the West Asia conflict started, fiscal policy, Nomura said, has been India’s first line of defense, which has minimized the growth/inflation trade-off but worsened the twin fiscal and current account deficit.  If these measures are voluntarily adopted by citizens or if the Strait of Hormuz opens soon, then the government may choose not to make any material policy changes, analysts at Nomura highlighted.  ALSO READ | Risk-reward less attractive for Indian stocks vs Asian peers: Goldman Sachs  "However, we believe the speech is a signal that the government is preparing citizens for a potential move forward with some policy announcements in coming weeks to reduce the pressure on the twin deficits," wrote Sonal Varma, managing director and chief economist (India and Asia ex-Japan) at Nomura in a recent coauthored note with Aurodeep Nandi.  “The pressure is building up to raise pump prices. Petrol and diesel have a 4.8 per cent weighting in India’s CPI basket, which means a 10 per cent increase could lead to a near 0.5 percentage point (pp) hit to headline inflation. A fuel price hike would also increase pressure on the Reserve Bank of India (RBI) to stay vigilant to any potential second-round effects,” Varma and Nandi wrote.  Those at JM Financial, too, see PM Modi's speech as a precursor to policy measures to actual austerity measures in a gradual manner if the conflict in West Asia lingers.  A prolonged conflict, they estimate, could moderate GDP growth to 6–6.5 per cent, and CAD could deteriorate to 1.9 per cent of GDP as inward remittances will also be at risk. Among other measures, they suggest the government should focus on increasing strategic petroleum reserves.  "We expect the government to follow a gradual approach; hence, fuel price may be increased in tranches, LRS limits may be reduced temporarily, and duty on gold imports may be hiked as the lean wedding season approaches," wrote Hitesh Suvarna of JM Financial in a recent note.