Akash Prakash: Keep the faith

There is no change as far as the long-term growth of the country and its corporate sector are concerned.

The Indian markets have just gone through another wrenching correction, in the course of which they have dropped by about 15%. If you exclude 3-4 large cap stocks like Reliance, Bharti and maybe ICICI, then most stocks are down more than 20%. India is also till date the worst-performing emerging market (among markets of relevance), and has experienced greater volatility than most. In what is now becoming a pattern, at the first signs of international turmoil, India corrects and corrects hard.

This correction traces its roots to both international developments as well as the underwhelming performance on the Budget by Mr Chidambaram and his team.

On the international front, as has been widely discussed, the sharp appreciation in the yen, leading to fears of an unwinding of the carry trade, spooked investors globally, as also weaker than expected economic data out of the US.

All markets corrected, across geographies and the risk spectrum.

Frankly I think all this is just an excuse for risk reduction, as risk appetite had got out of hand, with spreads for all types of risky assets compressing to silly levels, and widespread complacency. While things seem to be now slowly settling down, prior periods of risk reduction have stretched for at least 3-4 weeks, and it may be unrealistic to assume that everything is fine again in just about a week. We should expect some more turbulence and volatility before we can give the all-clear to global markets.

On the Budget presented by the finance minister on February 28, the market has clearly given it the thumbs down, and the disappointment felt by the market has only served to further hammer sentiment.

Without getting into micro details on the Budget, I think the markets' disappointment stems from 2-3 specific macro issues.

First of all, to me this Budget highlights how little room for manoeuvre this government has on reforms. If this is the best that Mr Chidambaram can deliver, with still two years to go for the Lok Sabha elections, then we should not delude ourselves into thinking that this government is reform-oriented. We should accept that nothing will happen over the coming two years on a whole host of pending issues, be it financial sector or pension reform, FDI caps or subsidy rationalisation. Nothing even remotely contentious or difficult will be attempted. It is sad that Dr Singh has let the reform agenda get sidetracked in this manner, but whether the left is at fault or higher-ups in his own party only insiders know.

Secondly, the manner in which the finance minister has been conservative in budgeting for revenue bothers me. This FM has always been aggressive in assuming high tax revenue, and then pushing the government machinery to deliver on the revenue targets. He has always bet on growth, and normally delivered. By assuming only 15-16% growth in tax revenue for the coming year despite achieving nearly 30% growth in 2006-07, what is the FM signalling? Is he trying to lowball the revenue numbers so that he is not forced to accede to more requests for handouts and can keep some semblance of fiscal order in expenditure composition?

Or is the FM accepting that an economic slowdown is around the corner? He cannot say publicly that he expects the economy to slow down, but his revenue numbers indicate limited buoyancy. If the economy is to continue growing at 9%, I cannot believe that he truly expects such a limited performance for tax revenue. Even more worryingly, he expects corporate tax revenue to rise by only 15%, after it grew by 40% in 2006-07. What does the FM know or see that we don't?

I only hope that he has been conservative on revenue to keep the big spenders in check, but let us see how the year pans out.

The third worrying signal is the re-emergence of the tendency on the part of the government to play god, and fiddle with industry-specific economics. Why target the cement industry? Is it really that crucial to bringing down inflation? Why is the government deciding what excess profit is? Who will the government target next, car companies, builders or, maybe FMCG companies? Are we slowly lurching back to price control and forgetting that we are supposed to be a market economy? I hope not and believe that the FM is too smart to let this happen, but it again highlights the politicisation of economic policy making.

The issue now becomes: What does one do at this stage of the market?

If we go back to first principles, then let's remember why we were bullish on Indian equities in the first place. The core reasons were as follows:

The Indian economy can grow in a sustainable manner at 8% for at least 10 years.

This 8% growth will drive earnings growth of 17-20% for the listed corporate sector.

India has a strong tradition of entrepreneurship and vastly improved corporate governance; if there are 50 world-class Indian companies today, there will be hundreds more after 5-7 years and they will be 4-5 times their current size.

Indian companies understand the cost of capital and are focused on shareholder value creation and returns on capital.

Is there any reason for us to doubt any of the above, because of this Budget and the international turmoil we are currently witnessing? The answer is that nothing has really changed as far as the long-term growth trajectory of the country and its corporate sector are concerned. Yes, we are downbeat on the government and its ability to perform, but the government's actions have still not been able to damage corporate sentiment. None of the industry captains I have spoken to is any less confident of their growth path or strategy. This is a powerful testament to just how irrelevant the government is slowly becoming (thankfully) and how low expectations have become. As of today I see no reason to change one's long-term outlook on the economy and/or markets. The big caveat to this is of course if the government continues to interfere at a micro industry level. Another 2-3 episodes similar to what they have done to sugar, petroleum or to cement can damage sentiment and harm investment plans. If the government were to move ahead on job reservations, that would be another big dampener.

However, barring the above, one should stay invested. We have had a very good run of four years of strong market performance, and it may be time for the markets to consolidate and catch their breath. It will be far more difficult to make money in 2007 as compared to the last four years, but that is only to be expected and not reason enough to bail. Large returns still lie ahead if you have the willingness to be patient and develop a quality portfolio.