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Stable govt crucial to boost investor confidence in a shaky economy

comment Updated: May 13, 2014 23:03 IST
Narendra Modi

Backed by the expectations fuelled by a string of exit poll results that a Narendra Modi-led BJP is likely form the next government at the Centre, India’s markets are scaling a new high every day and the benchmark Sensex is closing in on cantering past the fairytale level of 25,000. At the end of a gruelling six-week 2014 Lok Sabha elections, look who, apart from the politicians, have been glued to TV channels to catch the exit poll results: Investment bankers, fund managers, credit-rating number-crunchers and financial sector regulators. With billions of dollars at stake the outcome of the high-octane elections are critical to decide on investment decisions. For an economy hit by a toxic mix of rising prices, sliding economic growth and sagging political stock, the latest rally in equity markets should ideally give an occasion to rejoice in these strained times.

The real economy’s recent record, however, has been anything but spectacular. Industrial output fell 0.5% in March. Capital goods output contracted 12.5% during the month, mirroring how companies aren’t adding capacity lines, hit by weak demand, high loan rates and costly raw material. A sluggish overall economy, high interest and fuel prices have stunted the growth story across the consumer goods industry. That consumer durables output fell 11.2% in March mirrors this trend. The inflation numbers also underline the fragility of the real economy. India’s retail inflation rose to a three-month high of 8.59% in April on high vegetable and food prices. High inflation will also likely dash hopes of a possible interest rate cut by the Reserve Bank of India (RBI). The RBI has raised lending rates three times in the last eight months to tame inflation by cooling demand. RBI governor Raghuram Rajan has stated on which side of the fence the bank is on the inflation-versus-growth debate and its stated objective to bring down retail inflation to 6% by January 2016 leaves little room for rate cuts. The spectre of a failed monsoon looms large over the economy, which could push up food prices in the coming months.

The obvious question, therefore, is: What are the stock markets celebrating? Investors want a stable government and a continued push to resolving execution bottlenecks remains key to reviving capital expenditure. A stable government, many global investment bankers believe, will be good for the economy. However, given the rather shaky conditions in the real economy currently, a downward correction in markets should not come as a surprise. There have been several instances in the past where equity and currency markets have reacted sharply to even incremental developments in the economy. Retail investors should trade with caution.