India loses its lustre

by Deepak Gopinath


The ongoing debate on whether RBI should have hiked interest rates 50 basis points instead of 25 basis points at its most recent policy meeting may be interesting, but misses the point. The reality is that international investors made up their minds about India long before January 25. Inflation and what policymakers do (or don’t do) about it has been the primary focus of investors for several months now. Rising inflationary pressures have dampened emerging market equity performance and uncertainty about anti-inflation policies has been rising as price inflation of commodities from oil to coal to grains and softs continues to accelerate.

Given this context, investors’ verdict on India has been resoundingly negative. Compared to its BRIC peers, Indian equity markets have spectacularly underperformed over the last two months, falling 5%. That compares with declines of 2.6% and 0.9% in China and Brazil, respectively, and a rise of 9.4% in Russia. RBI and the government are perceived not only as still being behind the curve on inflation, but they also didn’t seem to care. Instead, policy overall is biased towards maintaining high levels of economic growth at all costs, setting the stage for a shift to a high growth/high inflation cycle that will depress equity markets in the near term.

How else can one explain the recent statement by the finance ministry’s Chief Economic Advisor Kaushik Basu that “we want to take steps to bring down inflation but we do not want to be so single minded in bringing down inflation that you have unemployment going up to 20%”. Or the RBI governor Subbarao’s repeated insistence that higher interest rates do not address the structural roots of food inflation, the driver of prices in this cycle. While technically correct, the explanation does little to mollify investors when the government remains unwilling to confront the causes of food inflation and invest in improving productivity of the agricultural sector. Or the business lobby’s call for a softly, softly approach to inflation lest it choke off growth.

Or the government’s unwillingness to roll back fiscal stimulus.

Now compare India’s schizophrenic attitude towards inflation with that of Brazil, where inflation is 5.9%, well above the 4.5% target. Since taking office on January 1, Dilma Rousseff, Brazil’s first ever female President, has gone out of her way to show how ‘macho’ she is on inflation, pledging in her inaugural speech to protect Brazil from the ‘plague’ of inflation and announcing cutbacks in government spending. On January 18, the Banco Central delivered and raised rates 50 basis points to 11.25%. This reassured investors that Brazil would do what it takes to keep inflation under control and sets up the possibility of a rally in equities once the turning point in the inflation cycle becomes clear.

Among the BRICs, the situation is Russia is the most favourable for equity investors. High oil prices are improving the government’s fiscal position and will help bring about a modest decline in inflation from December’s 8.7% level. That, combined with net capital inflows, will continue to sustain a rally in Russian equities over the near term.

The fact that China stands alongside India as one of the BRIC underperformers—Chinese equities have lost 2.6% since early December—is of scant comfort. China is also perplexing markets with its seeming lack of action on the inflation front, which is also largely being driven by rising food prices. But at 4.6% in December, Chinese inflation is much lower than India’s 8.4%, and the government is taking concrete measures to boost food supply that will prevent the spikes in prices that can destabilise markets and negatively influence inflation expectations.

In India, on the other hand, there is little evidence of a comprehensive strategy to address structural supply bottlenecks that are responsible for food inflation. And, even as RBI only grudgingly raises interest rates, there is little support for fiscal consolidation à la Brazil. Instead, the Congress is likely to go the other way, and keep in place subsidies on diesel and nitrogen-based fertilisers and continue to increase social sector spending that it sees as a key to continued electoral support. (The Congress faces five state elections this summer.)

The crisis of confidence in Indian economic policymaking couldn’t have come at a worse time. India’s carefully cultivated image of a relatively transparent democracy, with strong, stable, reform-oriented leadership, has taken a beating in recent months. And with it has gone the political premium Indian equity markets have commanded in recent years. The recent series of political and corporate governance scandals have not only precipitated a political crisis, it has weakened the government’s credibility and effectiveness. The recent half-hearted Cabinet shuffle only highlighted the leadership vacuum within the Congress-led government. The India brand will find it difficult to recover its mojo. And until then other emerging markets will take centrestage.

The author is global markets director of the research service, Trusted Sources

source;financial express