The “Greenspan put” was named after Alan Greenspan, former chairman of the United States Federal Reserve, and his desire to make sure equity markets in the US never fell on a sustained basis. It was an unwritten contract between Mr Greenspan and the market, wherein the Fed chairman took out the downside risk of a market meltdown, and thus encouraged market players to pile on risk. By implicitly promising to come in and cut interest rates whenever markets were in free fall, Mr Greenspan was giving market players a free put option by protecting their downside. Most notably, after the dotcom crash of 2000, Mr Greenspan cut interest rates aggressively to stem Nasdaq’s free fall and kept rates low for an extended period of time, as the Fed chairman sought to cushion the US economy and financial markets from the technology bust. In fact, many observers blame Mr Greenspan and this period of hyper-easy monetary policy for sowing the seeds of the housing bubble. Many market players also blame the notion of the Greenspan put for encouraging the excessive risk-taking and leverage in financial markets that eventually caused the financial system’s meltdown.
Fed Chairman Ben Bernanke has continued the Greenspan tradition and tried to use monetary policy to stabilise the economy and financial markets. He has gone a step further: he has explicitly targeted equity markets and made known his desire to see them rise through the various rounds of quantitative easing.
Now what does all this have to do with India and our honourable finance minister? I think the reality is that given how critical healthy and buoyant capital markets are to reviving the Indian economy, Finance Minister P Chidambaram will have to conjure up some type of put option of his own to ensure that equity and debt investors remain engaged with India.
Why are capital markets so critical? Most policy makers have identified cutting the fiscal deficit as a top priority to get the Indian macro story back on track. Given the difficulty in getting the coalition to accept the diesel hike and LPG-targeting measures, there are limitations as to how much the current subsidies and revenue expenditure can be compressed. We can see some further measures on fuel price hikes and maybe some movement on a nutrient-based subsidy on urea; but with elections only 15-18 months away, there are serious political costs to any subsidy cuts. There is also intense pressure on the government to roll out more freebies through the right to food, free medicines and so on. If expenditure compression is intensely difficult in the run-up to an election cycle, higher revenue is the only way to control the fiscal deficit. Given the government is simultaneously trying to improve sentiment and kick-start corporate investment, significant tax hikes are unlikely to be the path to increase revenues.
The obvious path is to monetise government assets, be it spectrum, coal blocks, surplus land or public sector unit stakes. The finance minister will have to do a lot more than raise Rs 40,000 crore from spectrum and Rs 30,000 crore from divestment. We will need to see movement on selling the SUUTI (Specified Undertaking of UTI) stakes, strategic assets like Hindustan Zinc, land with companies like VSNL, coal block auctions, etc. To enable the government to raise resources of the required magnitude, the capital markets have to remain healthy, both to absorb equity issuance and to enable companies to raise enough debt resources to participate in these asset auctions.
Capital markets also need to remain healthy to enable large Indian companies to recapitalise their balance sheets. While large infrastructure projects are stuck owing to regulatory issues, most of these project developers have stretched balance sheets and negative cash flows. The banking system is increasingly averse to putting new money to work with these developers and their projects. Unless the capital markets, both debt and equity, reopen for these developers, irrespective of regulatory relief, projects will not progress. No matter how much the finance minister and his team de-clog project approvals, without a healthy capital market and access to equity most projects will not move. Capital markets are also reflexive, in that access to capital by itself starts making previously unbankable projects and borrowers viable. Once a positive funding cycle commences, it improves sentiment, extends entrepreneur time horizons and reinforces itself.
We also need buoyant capital markets to fund the current account. While the current account deficit may go down from 4.2 per cent of gross domestic product (last year) to 3.5 per cent in 2012-2013, even this number has to be funded — and flows by foreign institutional investors are key. Equity inflows have already crossed $12 billion this financial year, and this positive momentum must be sustained.
The finance minister wants to re-establish India’s long-term growth trajectory, and healthy capital markets are a key part of the solution.
The only way the finance minister can keep investors enthused is to continue moving ahead rapidly with policy moves that need no legislative clearance. We have already seen a stream of announcements, and I think the momentum will continue. There is significant policy low-hanging fruit across sectors, given the virtual famine of reform in the past few years: revising investment norms for insurance companies, modifying the direct taxes code, new banking licences, a project investment board, and so on.
This finance minister is very investor-savvy, has conviction in markets, understands the key role capital markets will play in reviving the Indian economy and has a sector-specific game plan. It will be foolish to bet against him. He has the ability to keep the markets moving, if he can deliver policy action.
Obviously, political risk still exists, and the government may yet collapse before its full term. We must also acknowledge that the Congress high command may still get cold feet and go back into policy denial mode. However, absent that, Mr Chidambaram is signalling that he needs markets to remain buoyant and knows what needs to be done to ensure that they do. A lot of the policy measures needed to enthuse markets have little political downside; they just need co-ordination, better administration and decisiveness, which he can deliver. This is his version of underwriting the downside — delivering basic governance and policy action, enough to keep markets interested and investors focused on the long term. He cannot allow capital markets to go into a deep dive and be effectively shut for new fund raising. If that were to happen, then he has no workable game plan to get us out of this rut.
As long as the finance ministry can keep pushing ahead with reforms and keep convincing investors that decisions will be taken, markets are unlikely to correct significantly. Given the sharp up-move, the broad market indices may stay at these levels for some time; but within these indices one is likely to see significant sectoral churn. Investors have been hiding in the defensives, taking them to all-time high relative valuations. This is now likely to reverse. Most investors continue to disbelieve this rally: domestic investors have redemptions and majority of international investors are still positioned defensively. The pain trade is for this market to continue to go up, led by the more economically sensitive sectors.
That is what the country, economy and the finance minister need.
The author is fund manager and CEO of Amansa Capital
