Indian shares stayed positive through July as big regional and small South Asian markets fell, with global fund managers accounting for one-quarter of ownership, plowing in $1 billion for the month partially redeployed from China. Equity outflows were the norm in previous months coinciding with Prime Minister Narendra Modi’s first anniversary in charge, as price-earnings ratios at 20 far outpaced the emerging market average and tax, banking, infrastructure and land measures stalled. Valuations have come down to entice entry by domestic investors also pushed by falling gold prices where they keep wealth, but anxiety has heightened with a recent Finance Ministry proposal to expand the monetary policy council setting interest rates. Although outside member appointment is routine at central banks worldwide, the move smacked of pre-Modi official interference and seemed designed to undercut the individual power of popular governor Raghuram Rajan, and left investor sentiment flat going into the critical monsoon season.
Rainfall has been below normal, which could affect GDP growth already slowing from the 7% reported in the first quarter, with the PMI at 51 in June, and food-price inflation which has been the main contributor to the 5% CPI spurt with energy costs declining. However agricultural subsidies which were largely maintained in the budget also keep a lid on the category, despite the fiscal consequences as the 4% of GDP deficit will only be reduced gradually in the coming years, according to the government. The central bank lowered the benchmark rate by 25 basis points at its last meeting with room to maneuver within the 4% declared inflation target, but both seasonal and El Nino weather-related commodity uncertainty weighs on future farm prices. However at the wholesale and retail levels the readings have diverged, with the former imported products in deflation while cereals grown at home are up triple digits on an annual basis.
Larger cultivation plots could help reduce costs but the land acquisition bill pending in parliament, also vital for major infrastructure projects, has been fought by opposition parties on ideological grounds dating from the post-independence era that soil is communal rather than commercial property. Any eventual compromise will hand the issue to the states where blockages and complications could be even greater. Common-sense standardization is also elusive with the national goods and services tax under consideration. As a constitutional amendment it requires two-thirds majorities in both chambers and ratification by half of state assemblies. The Congress Party has insisted on an 18% ceiling for the levy while the ruling BJP and its allies prefer flexibility. Even with a gridlock break the earliest the GST could go into effect would be mid-2016, and the Modi team has indicated that privatization of state enterprises as a revenue alternative will remain modest in the meantime.
Public banks, with three-quarters of the market and reported bad loan ratios at 15%, will get $3 billion in recapitalization this fiscal year, but the state will retain majority stakes indefinitely. It may sell portions off to a maximum 52% under outline medium-term divestiture plans, but private buyers will be hard to find as almost all the twenty-five banks in the group trade below book value. Number three Bank of India posted an 85% profit drop the last quarter, as tougher non-performing credit rules kicked in from regulators. As with monetary policy conduct, the Finance Ministry has taken on the central bank to soften its stance, while acknowledging the need to shake up the bureaucratic top executives responsible for poor practices.
These squabbles contribute to increasing portfolio investor ambivalence despite virtual elimination of the current account deficit and a 50 percent rise in FDI in fiscal year 2015 to almost $35 billion. Private equity deals in India, mostly in high-tech, hit a record $7.5 billion through June but banking is still a taboo sector. Local government and corporate bond purchases remain capped by respective $30 billion and $50 billion annual quotas, as India’s brief China reprieve may not last against lingering impasse and intervention strains.
Gary N. Kleiman is an emerging markets specialist who runs Kleiman International in Washington, D.C.
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