It is not easy to measure collective market sentiment but one does get a sense of it when things change for the better. Something indeed appears to have changed for the better in just the three weeks into January. What seemed like a permanent feeling of resignation through the second half of 2011, when all the bad news had accumulated on both the global and domestic front, is giving way to some optimism that things may not turn out to be so bad this year.
The stock markets have shown a rebound in the past few weeks with foreign institutional investors (FIIs) pumping in over $1.3 billion in a space of 20 days. In net terms, FIIs had withdrawn around $400 million from Indian markets in 2011. The rupee had been under tremendous pressure over the last quarter of 2011, depreciating by close to 20%. Overall investor mood had remained sullen at the end of 2011. There was wide prognosis that the first quarter of 2012 would be worse in terms of capital flows. That, of course, has been proved wrong.
An appreciating rupee has made the Indian market most attractive so far this year, giving the dollar return of over 15%. Only a month ago many thought the exchange rate could touch R55 to a dollar. Now, after RBI?s surprise monetary easing on Tuesday and the Sensex coming back to the 17,000 mark, the market is animatedly talking about the rupee?s exchange rate coming back to the R48-49 range in the near term.
So, has something dramatically changed since a month ago? Well, humans cannot live with bad news for too long and naturally start looking for silver linings in the dark clouds. A peculiar set of circumstances seems to have brought such silver linings to the fore. On the global front, the assurance of a substantial quantitative easing (QE) programme by the European Central Bank (ECB) and injection of liquidity into the large European banks to aid government bond purchase has somewhat allayed apprehensions of capital flows from Europe suddenly drying up. If anything, the ECB expanding its balance sheet could result in more liquidity flowing to emerging markets. This is exactly what had happened when the Federal Reserve had expanded its balance sheet from $500 billion to about $3 trillion after two phases of QE.
Of course, the European QEs will pose the risk of oil and other commodity prices climbing up in the medium term. But the silver lining is India?s immediate capital flow requirement will be addressed. So, ECB printing more and more money is good for India at this juncture.
Once capital flows resume, the investment machine will also start moving. With inflation moderating, there is a hope that growth will start to pick up in 2012. RBI, while cutting CRR by 50 basis points, has projected the GDP growth for the next fiscal at higher than 7%, the revised GDP for 2011-12. RBI is doing its bit to create some investment optimism for 2012.
Of course, RBI has hinted it could do much more if the government showed some resolve to improve the quality of the fisc in the forthcoming Budget. The markets will now look at what finance minister Pranab Mukherjee does in the 2012-13 Budget to be presented mid-March. If Pranab Mukherjee signals a three-year fiscal deficit reduction plan by close to 1.5% of GDP, that will act as a major boost for private investment sentiment.
There is another elephant in the room that could turn out to be greatly beneficial for investment sentiment. The elections in Uttar Pradesh will perhaps be as important as the Union Budget itself in determining where the economy is headed in 2012. Big ticket reforms like FDI in retail and critical legislations like the Land Acquisition Bill had been put off until the Uttar Pradesh assembly polls. So, the outcome of Uttar Pradesh elections has a significant bearing on which way economic reforms are headed.
So far, private surveys done by both the Congress and the BJP reveal that the Samajwadi Party (SP) could emerge as the single largest party in a highly fragmented house. There is growing resentment among the youth against the visible corruption and wastage of public funds under the Mayawati-led regime. In a highly fragmented voting pattern, just 2-3% votes moving away from Mayawati will open up the possibility of the SP and the Congress getting into a post-election alliance. This possibility is widely being speculated by pollsters. The Congress has already struck an alliance with the Rashtriya Lok Dal headed by Ajit Singh who is now a minister at the Centre.
If the SP does well and is able to form a government with the Congress?s support, its leader Mulayam Singh Yadav will most likely decide to join the UPA at the Centre. Mulayam Singh Yadav has a good equation with Manmohan Singh as the former had helped push the nuclear deal when the Prime Minister needed critical support in 2008. Without the malevolent influence of Amar Singh and other wheeler-dealers who have got gradually weeded out, SP will be more than acceptable to the Congress President Sonia Gandhi too.
Once the SP joins the government, the UPA?s reforms will not fall victim to the whims of Mamata Banerjee. Some of the key legislative reforms will start moving as the SP is far more pragmatic about economic reforms than the Trinamool Congress, which has positioned itself to the left of CPI(M). The SP entering the UPA alliance has the potential to kick-start reforms in 2012.
mk.venu@expressindia.com