Indian markets are expecting the new FM, Mr. P. Chidambaram to deliver market friendly policies to improve market sentiments. Market friendly policies include encouraging portfolio flows from abroad, investor friendly tax laws, arm twisting RBI to reduce rates and providing fillip to the domestic mutual fund industry. Markets thrive on liquidity and easier the access to liquidity the better for markets, in the short term. Markets and market participants have a short term outlook and profits today matter more than potential losses tomorrow. Indian equities are in a four year bear market while its currency is at close to record lows against the USD. Mutual fund assets are down over the last four years. It is no wonder that markets are looking at the “market friendly” FM for respite.
Market friendly policies are not necessarily economy friendly policies. Infusing liquidity into markets creates bubbles, which when it bursts cause long term pain. The liquidity bubble burst in 2008, when the mortgage crisis emanating from the US took down markets and economies across the globe fueled the pain the markets are going through right now.
The FM should not give in to the demands of the market. Instead the FM should focus on strengthening the economy for the long term and that by itself is going to take up most of his time. He has to buy consensus on tough policy reforms of reducing fuel subsidies. He has to make power producers and distributors including state level undertakings of State Electricity Boards profitable and he has to introduce the GST (Goods and Services Tax) as quickly as possible.
The FM also has the tough task of handling an economy where growth is coming off and inflation is rising. RBI has revised GDP growth forecasts for 2012-13 to 6.5% from 7.3% levels and has raised inflation estimates from 6.5% to 7% levels. The government’s fiscal deficit projected at 5.1% of GDP for 2012-13 is expected to go up to over 5.5% of GDP levels on the back of slowing GDP growth and weakening government finances.
Market friendly policies are politically acceptable while economy friendly policies are politically unacceptable. The question is does the FM have the political backing to take economy friendly policies? A diesel price hike will not only help bring down fiscal deficit but will also give RBI headroom to use monetary policy to ease falling growth pressures. However given the rising inflation expectations due to weak monsoons, there will be a huge political hue and cry over diesel price hikes.
The failure of power grids in the North of India in end July 2012 brings to focus the poor financial conditions of state electricity boards (SEB’s). SEB’s are running into deep losses, estimated at over Rs 200,000 crores and banks are unwilling to fund them given the provisions they are making on SEB loans. Lack of bank funding to SEB’s is forcing power producers to refrain from selling power to SEB’s. A gridlock is created where power producers with power to sell cannot sell leading to shortage of power. The FM has to free power prices in order for the SEB’s to at least break even on power sales.
The introduction of GST is pending for almost two years now. It is required to be introduced on an urgent basis as the government is facing the prospect of rising fiscal deficit. FM has to focus his attention on GST introduction.
Over and above all this, the FM has to handle pressure emanating from global economies including sovereign debt crisis in the Eurozone, weak China growth, record high food prices in the US due to drought etc.
The FM has his work cut out and if he does succeed in strengthening the economy, the market will automatically pay him back for his efforts. On the other hand if market expectations get too high and the economy does not deliver, the fall will be even more severe.