India is yet to come out of a five year bear market and while 2013 could take the Sensex, Nifty, Ten year government bond and the INR higher, it is unlikely that the markets will enter a bull orbit. A sustained rise in markets requires a far stronger fundamental footing than what is present now in the economy. It is true that markets look forward and hope for the best but for a forward looking market, it is not enough for an economy to come out of a trough. The economy has to have the footing to move ahead without creating issues of inflation and asset bubbles. India is not in that wicket yet.
Calendar year 2012 has been good for Indian equities and bonds. The Sensex and Nifty have climbed by over 25% each while benchmark ten year Indian government bonds have returned around 12%. The Indian Rupee (INR) on the other hand has lost over 3% to the USD, which looks to be an aberration considering the rise in equities and bond prices.
The year 2013 is widely expected to be a good year for the Sensex, Nifty, government bonds and the INR. The reasons for positive trends include liquidity flows from abroad on the back of loose monetary policies followed by central banks across the globe including the Fed, ECB and Bank of Japan. The RBI is also expected to ease policy starting January 2013 while Indian corporate sector is set to show better performance going forward given an improvement in growth outlook for the economy in 2013-14 from lows of around 5.8% GDP growth (expected) seen in 2012-13.
The question is whether this equity rally is the start of a fresh bull run for the markets or is it still a bear market rally? The Sensex and Nifty are still down from highs seen in late 2007 and five year returns are still negative. The INR is just off 5% from lows seen in mid 2012 and is down over 20% from levels seen five year ago. Ten year benchmark bond yields at 8% levels is around the same levels seen five years back. Hence on a five year period basis Indian equities, currency and bonds have given bear market performance.
Where is the economy now and what should be done going forward?
Indian macro is very far from looking good. GDP growth expected at 5.8% for 2012-13 is at ten year lows. India’s fiscal deficit forecast at 5.3% of GDP is up by 250bps from levels seen five years ago. India’s wholesale price inflation at 7.25% levels as of end November 2012 is higher than levels of 3.7% seen in November 2007. The current account deficit at 4.6% of GDP for the first half of 2012-13 is the highest on record.
What are the policy makers doing about the poor macro conditions of the economy? Apart from recognizing the poor macro fundamentals and taking short term measures to improve the fundamentals, policy makers are not taking any long term fundamental steps for sustained economic growth. In the short term markets will embrace any positives on macro but in the long term a sustained deterioration in the macro will tell on performance as seen by the five year poor performance of Indian equities, bonds and the currency.
The government instead of focusing on subsidy reforms, tax reforms, labour reforms and other such important reforms is focusing on better delivery of subsidies, better collection of tax and stability in jobs for government employees. Direct cash transfer is good but it does not bring down fiscal deficit. Improved tax collection is fine but it does not bring in black money back into the system or dramatically improve the tax to GDP ratio. Government employees are not measured on productivity leading to a large unproductive workforce.
The list of reforms required for the economy to get on a strong footing is endless. Unfortunately the government does not think long term and is keener on retaining power in 2014 and that leads to issues of whether the economy can get on a sustainable growth path.