The biggest risk faced by investors in Indian equities, bonds and the currency at present is political risk. Political risk exists in the form of worry on mid term polls at the center, lack of sound fiscal policies, mismanagement of states, cases of scams and corruption and the media blowout of any political issues. Investing when political risk is high is tricky as short term volatility could kill future investment appetite. Investors should learn to navigate political risk rather than stay off investing.
The ruling UPA government at the center looks to be on a shaky ground with many of its allies either going against them or they themselves losing political ground. The election at the center is scheduled for calendar year 2014, but if there is a political shakeout, the polls could be advanced. The government has overshot its fiscal deficit for 2011-12 by 1.3% and though it has budgeted for a lower fiscal deficit of 5.1% of GDP for 2012-13 against 5.9% of GDP for 2011-12, the lack of reforms on subsidies and taxes are telling.
State finances are hugely mismanaged with exceptions of a very few and deteriorating state government finances is hurting sentiments amongst businesses as well as consumers. The power problems faced by states due to the deep losses of the state electricity board (CRISIL estimates losses of Rs 1.80 lakh crores for 2011-12) highlights the mismanagement of states.
Scams and corruption are daily headline grabbing affairs and there is a new one unearthed everyday. 2G scam trials, corruption cases in mining and other such cases are hurting market sentiments. The media is also playing its part on the investors mind by blowing out all kinds of political risks to gain viewership. High levels of media created political risk unnerve investors.
Tackling political risk
The investor has two options in the face of political risk. One is to stay out of the market and the other is to navigate the risk. Staying out of the market could mean missing good investment opportunities as markets may just overlook political risk when there is good global investment appetite for risk assets. Navigating political risk is a better option as it helps investors make sound investment decisions in volatile markets leading to better returns when volatility stabilizes.
Five rules of navigating political risks when making investments
- Political risk affects businesses that are impacted by government policies the most. Investors should stay away from sectors and stocks impacted by government policies. Government policies affect government owned businesses the most as seen by examples of fuel subsidy burden borne by ONGC or lack of capital available for oil marketing companies due to inadequate and timely compensation by the government for subsidy losses. PSU stocks are best avoided at times of high political risk.
- Businesses that are involved in scams and corruption cases are best avoided, as witch hunting will go on for a long time. Bottom fishing such stocks will not bear fruit. Corporate governance should be the primary focus of investors when political risks rise due to unearthing of scams and corruption cases. Companies with best corporate governance practices and with good clean image should be the choice of investments.
- Mismanagement of finances of the states hurt state run companies such as state electricity boards. Companies earning revenues from selling to state run companies will suffer. Investors should avoid investing in stocks that have a high degree of dependence on the state for revenues.
- Poor fiscal policies of the government affect interest rates negatively. High fiscal deficits add on to inflation while high market borrowing leads to pressure on yields on government bonds. Rising inflation and rising bond yields leads to high interest costs in the economy. Investors should lower exposure to interest rate sensitive stocks at times of fiscal stress.
- Threats of mid term polls have a negative effect on the broad market. Market volatility rises as talks of mid term polls surface or recede. Calibrating investments on worries of mid term polls is difficult and will usually go wrong as it is not easy to predict the outcome of political games. Investors should focus on a wider range of fundamentals at times of poll risks rather than just the poll risk factor itself.
Political risks also come off when there is stability of the government or when the government is forced to implement unpleasant near term policies for longer term gains. Investors should then look at revisiting investments that were avoided at times of high political risk.
