Sanjay Negi's thoughts on Current Affairs and Information Technology Directions.


Saturday, August 12, 2006

Where are Indian Stocks Headed

Track any Index like the Dow or BSE Sensex and the long period average is found to be close to the bank rate even though there may be violent fluctuations over a five year time frame. Why do investors get attracted to Stock Markets and more imporatntly how do they still make money. Is it rally a zero sum game?

The stock market indices represent the corporate sector which in turn is the productive part of any economy and would therefore in some way reflect the economy's underlying performance. In a highly corporatized economy, it is natural that the stock indices would in some way reflect the growth rate of the overall economy which in turn would bear some relationship to the bank rate. In a developing economy like India, the corporate sector represents a much faster growing but smaller proportion of the overall economy and the long term indices would therefore reflect this reality.

The Indian economy is expected to grow at 7 to 8 percent annually in the forseeable future. Considering that this overall growth would happen inspite of being heavily weighed down by the Agricultural sector and the parasitic Government sector, it should translate into a corporate sector growth of over 15% after adjusting for inflation. If we do not count inflation the corporate sector growth would reflect a higher figure of over 20%. The indices should therefore reflect this wealth creation in the internediate term.

In the past the BSE sensex has merely kept pace with the bank rate because the economy grew at 2% and corporate growth rate was a few times that number which matched with the average long term bank rate. In that sense India had a stable predictability about it as one would expect in a saturated or developed economy. From now on we can expect the sensex to beat the bank rate by a large margin till the economy cools or is made to cool down by our venerable political managers who have the knack of finding highly imaginative and innovative ways of strangulating the economy in the name of the people. In this holy endeavour they are ably assisted by the bureaucracy who still believe wealth creation is sinful.

Within the corporate sector, industries dependent upon exports like IT Services would continues to do better than others as the labour arbitrage would offer a compelling case for sourcing from India. As the post modern economies in the developed world keep consuming more and more computing infrastructure, this sector of the Indian economy will find the sun shining brightly for them for a long time to come. Indians being naturally gifted are ideally suited for this kind of fuzzy service delivery models and there seems to be little competition on the horizon. With the number of Engineering graduates being churned out by hundreds of institutes, resource costs should not be an issue at all.

What are the risks which can pose some threats to this pretty evolving picture? The biggest risk continues to be our government and bureacracy. We must not forget that the current phase of liberalization actually happened at gun point. In 1991, the country was almost declared bankrupt and therefore had to be bailed out by IMF who imposed structural reforms. The then Finance Minister who is also the current Prime Minister was quick to take credit for the reforms, but we must remember that the Congress lost the subsequent elections as the vast majority of the population then and even now does not approve of the reform process.

The Congress did not come back to power promising more reforms, indeed it was quite critical of the market friendly leanings of the NDA government. More ominously, the Congress is in power at the pleasure of the Communists who are rabidly anti market and think reforms are workable only in China not in India.

If we look at the economic growth in the last few years it is because of the energies released at gun point in 1991. Nothing much has happened since then. Whoever has spoken in favour of the market has been voted out. The Indian public continues to be vastly suspicious of market forces and continues to place its trust in the populistic politicians and crafty bureaucracy considering them to be the lesser evils. The only elections the NDA won were on the emotional planks of Ayodhya and Kargil not on sunstantive issues of governance or economic growth.

Why then is the current government not rolling back the liberal policies of 1991?

The Congress Party has always taken its cues from the global fads, flavours and fashions of the age. In the first half of the 20th Century it was anti imperialist as that was the politically moral thing to say and even earned one respect from the intellectuals of the day. In the 50s and 60s with communism threatening to sweep large parts of the palnet, the Congress party quickly donned the socialistic idealogical mantle and even nationalized large parts of the economy like Banks, Airlines and Heavy Manufacturing, thus laying the seeds for economic stagnation for the next 40 years. On the advent of Thacherism and Reagonomics, and more so on the failure of the Soviet experiment, it became globally fashionable to talk of economic reforms. Sure the Congress Party was again swinging to the new tune.

The Congress perhaps has no idealogy of its own. Therefore in the current global belief systems, it would not roll back reforms on its own. However being a master of demagogic populism, it knows what not to say. The Indian voter does not want to hear of market reforms, and so we will not hear this from the Congress. Essentially one can expect a status quo with no new bold steps but with a slightly anti market rhetoric.

The risk of roll back of the modestly Liberal policy framework is probably low for the time being, and the continuity should provide stability and predictability to the business environment. I expect the growth rate to continue in the 7 to 8 percent range and this would fully reflect in the Stock market indices moving at 20% per year on an average.

On the liquidity front, global funds may create some ripples now and then, but the valuations in the index heavies being already quite unfavourable especially when compared with other emerging markets, this doesn't look sustainable and any impacts can be possibly ignored in the calculations.

In the mildly liberal business environment that obtains in India presently, it has become relatively easy for smaller companies to do business and grow. Value creation in the medium and small sectors may even outpace that in the large corporate space and therefore those stocks though much more risky may also offer dizzyingly attractive returns.