R Ravimohan: The real new deal

The policies of the UPA government have benefits that are not immediately discernible

The equity markets have been directionless for the past six months, clearly limited in ability to decide on the impact of the new government dispensation, rising oil prices, inflation, rising interest rates, and robust corporate performance.

The markets have therefore been range-bound and have swayed transiently with so-called "expert" interpretations. The debt markets, foreign exchange markets, and the commodities futures markets appear to have all taken their calls""the bond and the foreign exchange markets are bearish, and the commodities futures markets mostly bullish.

This is reflected in the rising bond yields, depreciating rupee and rising futures prices of most commodities. Why is the market caught in a quandary? What view should it take of the various political and economic elements affecting corporate performance?

There has been a 180-degree change in the paradigm of decision making between the present dispensation and the old regime. The market does not seem to have come to terms with it. The old regime was much more urbane and deal-oriented. It therefore appealed to the suited-booted-tied species of equity investors.

The orientation was not only in the nature of priorities, but also in methods. The disinvestment programme of the two governments is a classic indication of this approach. The previous government chose those units to privatise/disinvest that appealed to the above-mentioned category.

This programme allowed a lot of play in equity prices, and therefore was welcomed by the market. The markets hailed the disinvestment programme to be reform-oriented.

However, the new government, even before it took office, turned this programme on its head and talked of no more disinvestment of the nature that the markets had come to adore. That threw the market off-balance, from where it is yet to recover its faith in the new government.

While the new government has ruled out the get-rich-quick style disinvestment, I believe it will pursue the agenda in the broader framework of public sector reform. If some public sector units need to be restructured or rehabilitated for reducing losses and government support, they will be privatised or disinvested.

In a sense, this could be characterised as real reform versus the previous style, which could be characterised as more market-facing reforms. Nonetheless, it is reforms, and it affords a fair degree of market play, though requiring harder work and a lot more sticky.

The same theme flows in almost all other major economic agendas of the new government, such as rural development, employment generation, government investment, or foreign direct investment. There appears to be a much greater grounding of policy framework in the real sector than the policies of the previous government. I believe this is good for the larger economic development of our country.

The benefits to the market from these policies will be back-ended and less discernible. But they will be more sustainable and rewarding. These policies require patient capital, as opposed to transactional capital, which the previous government policies seemed to attract.

These policies per se are good for an economy that is still to cater for a large population of the poor and unemployed. The question as to whether these policies will be implemented as well as they are intentioned, is an age-old refrain that is not being addressed in this article.

Rural development and employment generation converge into a number of good possibilities in terms of new programmes. Rural roads, power, and telecom will involve large capital outlay, which will be a good driver. It will also give better market access to corporates, who desperately need to increase penetration into rural areas.

There is also a likely furtherance of sectoral policies on telecom, power, and transportation, which will encourage the much-needed investment from both the public and private sectors.

On the FDI front, there is a danger in extrapolating the past trend. The negative from the political perspective could be borne out of fear that FDI will force a closure of Indian industries and therefore throw people out of jobs. However, given its priority for job creation, government policies will support FDI in employment-generating jobs.

Indeed, economically too, foreigners will invest in India largely due to perceived labour cost advantage and will therefore invest in industries that are labour-intensive.

This increased FDI flow augurs well both to the economic cycle and for a stronger rupee, which could help abate the inflationary pressure somewhat. In other words, the government policies are likely to be oriented towards real development.

All these are not necessarily bad from the equity market's perspective. However, the market needs to reassess its expectations and start looking for the goodies from an entirely new set of drivers.

On the face of it, the economic variables also appear more hostile than six months back. Inflation is up, so are interest rates. But are these bad developments for corporate performance? According to CRIS-Infac studies, almost all industries are operating at above the 80 per cent capacity this year.

While some incremental de-bottlenecking and capacity augmentation are continuously happening, there has been no major capacity creation in most industries. There is a window of about two to three years, during which time new capacities will be built when corporate performance will be buoyed by inflation. In addition, the new investment cycle that will begin now will itself rekindle dormant economic drivers.

Indeed, CRIS-Infac's studies show that there will be scarcity in most commodities, and opportunistic pricing may become widely prevalent. Higher inflation due to higher demand is good for corporate profits.

Unfortunately, the spike in prices this is now inevitable due to impending shortages will push input costs for industry. However, given the favourable demand-supply situation in most industries, corporate profits will remain healthy for the next couple of years.

Most industries have also used the previous few challenging years to consolidate themselves both at the industry and at the unit level. Demand for higher funds will drive interest rates up. Given the lack of investment opportunities in the past five years or so, savings have been sloshing around the system, wantonly seeking easy return opportunities.

However, as investments in new capacities become attractive, as they are bound to, these funds will now work for real investments rather than market transactions only. These factors ought to give the equity market a ride up in the near future.

Combining the political and economic realignments, fresh investment strategies are needed. Taking positions on stocks because they are expected to be divested by the government or because the government would allow foreign holding to go up perhaps will not fetch the bounties they fetched for the past couple of years.

Grunting ground-up and identifying companies with pricing power and those that are ahead in the investment curve will surely yield sustainable returns for the markets.

In other words, the influence of fundamental factors, which had receded in the past few years, will come to the fore. That's the real new deal.