)
The Indian equity market has hit an all-time high on the back of the ongoing "hope" rally. The avowed reasons for this rally are positives such as improvement in current account and fiscal deficits, the possibility of softening inflation - though largely on account of the base effect - some baby steps in un-stalling the several stalled projects, the continued increase in regulated diesel prices, market resilience despite the US taper and of course, opinion polls indicating a decisive government in May. Given the ferocity of the recent up-move, it is worth examining these positives in some detail.
The low annualised 0.9 per cent of gross domestic product (GDP) current account deficit figure of the third quarter of FY14 is on the back of severely compressed gold imports which are at a sixth of the the third quarter of FY13 figure, as also a 7.5 per cent increase in exports and a sharp 14.8 per cent decline in imports.
The sharp 13 per cent depreciation of the rupee over the last 12 months has certainly contributed to the improved export performance. However, India's export competitiveness has significantly eroded over the last few weeks with the steep depreciation in the currencies of our export competitors. The surprisingly low six per cent growth in software exports in the third quarter of FY14 - less than half the expectation - is certainly a matter of concern, as also the sharp increase in gold smuggling to meet robust domestic demand which would eventually affect the trade balance.
The eight per cent fall in non-oil, non-gold imports suggests weak domestic demand that is unlikely to cheer corporate earnings. The stark reliance on postponement of subsidy payments, deep cuts in plan expenditure and appropriating the cash balances of public sector undertakings (PSUs) for high dividend payments and parking of government divestments in PSUs to contain the fiscal deficit will certainly have economic consequences in FY15. The much-delayed and halting progress on a few of the stalled projects could possibly bear fruit over the next few quarters but this has hardly changed the subdued investment intentions of entrepreneurs.
The first two instalments of the US taper have left Indian equities largely unaffected but it is worthwhile noting that in the first two months of 2014 - when the US taper was in play - foreign institutional investor (FII) inflows into equities have dropped to $0.36 billion from $8.6 billion in January-February 2013.
That brings us to the market's base case of a strong government in May, based on opinion polls. The memories of 2004/2009 when most of the opinion polls got the election outcome spectacularly wrong are too fresh to ignore. Even if the main opposition party were to get 200+ Lok Sabha seats, the political space their leader would enjoy in implementing market-friendly policies would be largely dependent on the type of coalition that can be stitched together.
Moreover, the bureaucracy - which is seen as a significant contributor to governmental indecision/inaction - needs to be re-energised, concerned as it is about the collateral effects of the Right to Information Act and the long-drawn investigations on and detention of some of their senior ex-colleagues.
While sentiment can take the market to a new high, this needs to be eventually backed by robust earnings growth, benign interest rates and a potential valuation upside. These factors are clearly unfavourable at this juncture and hence continued strong FII inflows despite unsupportive market fundamentals - early indications of which are not encouraging - would be the main determinant of any further upside.
The author is director, Dalton Capital Advisors (India) Pvt Ltd
