The central bank will have a tough decision to make after the inflation numbers come in. The Reserve Bank of India (RBI) gambled in December, by holding rates unchanged in the face of higher inflation. That doesn't seem to have helped, going by auto sales.
India Inc is now pleading for rate cuts with the IIP down. Anecdotal data suggest vegetable prices have dropped and that may have pulled the Consumer Price Index (CPI) down, though it won't affect core inflation. A low CPI may give RBI room to cut. However, if inflation has not really abated, the RBI may take a hard line and hike rates. (Click for charts)
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The current account deficit has shrunk substantially but the export slowdown makes it psychologically difficult to normalise gold imports norms despite very low gold imports in December. The fiscal deficit is running higher than budgeted. The disinvestment programme has so far raised less than Rs 1,500 crore against a target of Rs 40,000 crore in 2013-14. The market reaction to the proposal to sell off the Specified Undertaking of UTI stake in Axis Bank has not been positive.
Another looming worry is the possibility of a stream of defaults on bank loans in the next 12 to 15 months. A recent report by a Fitch Subsidiary, India Ratings & Research, pointed out that 20 of India's top 100 corporations have already made restructuring requests or defaulted on debt in the current fiscal.
In fiscal 2014-15, this set of stressed companies will need to refinance, or repay loans amounting to four to five per cent of the net worth of the banking sector. Given the overall conditions, it is likely that some of those corporations will default. A large number of them are highly-leveraged infrastructure players, who could also be forced into distress sale of assets to deleverage.
The stock market has corrected through the last 10 sessions with the major indices falling even though the breadth has remained positive with a good advance-decline ratio. The dichotomy is easily explained. Retail traders are speculating in smaller stocks while the foreign institutional investors (FIIs) have been more or less absent, and the domestic institutional investors have been net sellers.
A hiatus in FII operations is quite normal in early January as they review strategy in the new year. However, the start of tapering has meant added tension. Will the FIIs cut back emerging market operations as the US Fed slowly closes the tap? December employment data out of the US have been weak, which means that the quanta of tapering is not likely to increase for a long while.
Politics is bound to feature in any FII projections. Prospects on that front may have worsened as they see it. The "business-friendly" Bharatiya Janata Party has just mooted a tax proposal (the repeal of income tax, coupled to the imposition of a banking transaction tax) that borders on the insane. That will almost certainly be shot down before it becomes part of the campaign platform but it has somewhat shaken the faith of investors in the BJP's economic agenda.
The probability of political instability has risen with the advent and proliferation of the Aam Aadmi Party (AAP). It could be difficult for the National Democratic Alliance (NDA) to win a stable mandate as most investors were hoping. AAP's stunning success in the Delhi Assembly elections and its appeal to urban voters could undercut the BJP voteshare. Given the fledgling AAP government's action so far on the water and electricity fronts, investors are understandably nervous about it playing a national role.
An unstable coalition or a hung Parliament that led to an unstable coalition could lead to massive capital flight. However, speaking personally, I'd say a weak coalition that doesn't think it can last is actually more likely to initiate reforms India needs.
The two periods when reforms actually occurred were between 1991-93 and 1999. The first phase involved a minority Congress government, which promptly stopped the reform process, once it was stabilised with the induction of the Jharkhand Mukti Morcha. The second phase involved a lame-duck NDA government, which passed a lot of useful legislation after losing a Vote of Confidence.
Reform in the Indian context means politicians and babus putting a monetary value to their discretionary powers and then relinquishing them. An unstable coalition has more incentive to do this. Any government that believes it is stable is far more likely to milk the country for whatever benefits accrue, for its entire five-year term. That said, there is no guarantee, of course, that an unstable coalition will initiate reform.
Coming back to the present, Q3 corporate results have just started being announced. Infosys is doing well under the old/new stewardship of N R Narayana Murthy and son. This could mean a fillip for other tech stocks. Banks and realty look weak. This weakness could intensify or reverse after the inflation numbers are known.
Technically speaking, the major indices remain range bound with the Nifty stuck between 6,100-6,300. The dollar has also seen low volatility. Changes will come only once there's an inkling of FII attitude. The direction will, of course, depend on whether FIIs go net positive or negative.
But volatility is guaranteed to rise and option traders can buy volatility. The Nifty could swing 300 points in either direction in the next fortnight and it could be set up for a bigger trend. The dollar could swing by a rupee or more. These projections can be offset by strangles - long calls and puts, which are available relatively cheap due to the current volatility being low.