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FII fear: Will reforms hit a wall?

May 27, 2004 07:50 IST

The Indian stock markets have been witnessing immense volatility (with a negative bias) ever since the first exit poll results came out last month. Since then, the Indian indices have behaved in a fashion opposite to that was being witnessed since April 2003.

And this trend reversal could largely be blamed onto the investor community, which was very much responsible, in the first place, for the rally that was witnessed in Indian stocks.

We are talking about the foreign institutional investors (FIIs) who invested into Indian equities for 18 consecutive months since November 2002 with investments totaling a massive Rs 471 billion (about $10 billion).

However, in sharp contrast to this, during the month of May 2004 alone, FIIs have pulled out almost Rs 33 billion. So what has caused FIIs to pull out of Indian stocks?

While we continue to believe that it is not just politics that has led to this negative behaviour of FIIs, it seems that a substantial 'credit' of this could be given to the uncertainty that has been created with respect to the India story going forward owing to a new government at the Centre.

The recent weakness on the Indian bourses is a clear testimony to the fact that political stability is of key importance for outsiders investing into our country. This is because political stability is the re-affirmation of the continuation in policies in practice in the country, which stand the risk of a possible discontinuation in the event of a change in the government.

This is precisely what happened with respect to Indian stocks markets as investor fears came true.

First it was the big surprise of the change of government at the Centre, which took almost all market participants by surprise. As if this was not enough, statements by certain allies (aimed at making the party stand clear) of the incoming coalition government upset investors, especially the FII community.

This was because the cues that were coming out of the new government seemed anti-reformist and anti-growth for the Indian economy. However, the nervousness for FIIs did not end here as some of the ministers actually went ahead and announced the implementation of certain measures, which are very much a reversal of the measures implemented by the previous government.

Let us look at a few of the measures that hurt investor sentiments and seemingly does not augur well for the growth of the Indian economy:

Divestment: Markets were expecting the privatisation process of various PSUs like Nalco, HPCL, BPCL, et cetera to continue.

However, with the government (along with its allies) opposed to privatisation of profit making government companies, it is a clear indication that the divestment process has been put on the back burner.

Power: The announcement of the distribution of free power to the farmer community in the states of Tamil Nadu and Andhra Pradesh would act as a big discouragement to private investments in the sector.

Further, with expectations of the continuation of cross-subsidies in the sector, this would put the brakes on the recovery of the state electricity boards in the country and would consequently lead to the derailment of power sector reforms.

Banking: While the previous government encouraged privatisation and consolidation in the banking industry, the incumbent government has made its intentions clear that it would not part with its stake in public sector banks.

Further, the removal of the 10% voting cap also seems difficult now. These measure go against the banking sector reforms.

FDI Limits: On the basis of the intentions of the present government, an increase in the FDI limit for the telecom, retail and insurance sectors now seems a bleak possibility. One more anti-reform stand!

Fiscal concerns: With the government having indicated the continuation of subsidies for the agricultural sector and an increase in public spending, there would be increasing pressure on the fiscal position of the country, which is already very disturbing as the consolidated gross fiscal deficit of the country hovering at 10 per cent since last several years.

These populist measures like subsidies, free power, no increase in tax rates and missing revenues from divestment, paints a gloomy fiscal picture of the country.

Considering all of the above (and many more), early indications point to the possibility of the reforms process in the country hitting a speed-breaker, if not a wall.

However, considering that the Congress has always portrayed itself as the architect of Indian reforms, it is only after the Common Minimum Programme and the Budget (likely to be presented sometime next month) that a definitive view should be formed. is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.

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Number of User Comments: 1

Sub: Dont worry, gentlemen ! they (the reforms) will not hit the wall.

At the most they may heat a black hole. However, that is nothing to be worried about. It will be very smooth, and without any ...

Posted by chanakya


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