We believe that the measures announced in last week’s budget will do little to strengthen the position of the current coalition government.
The attempt to tackle the budget deficit through a retrospective grab on capital gains tax on cross-border acquisitions (prompted by Vodafone’s victory in the Supreme Court against such levies) may not have a significant impact on future foreign direct investment decisions, but it certainly raises questions over the strategy of the incumbent government. The recent resignation of the railway minister, Dinesh Trivedi, follows disquiet in his own political party – Trinamul Congress – over fare increases announced last week, and serves only to raise further questions over the stability of the multi-party United Progressive Alliance coalition led by the Indian National Congress. However, steps taken to broaden the tax base will improve government finances and the increase in personal tax allowances will help the middle classes and continue to support consumption growth.
In our opinion, the events over the weekend should not detract from the positive message which we believe was delivered in state elections held during February and March, which were largely unsupportive of the coalition government. Uttar Pradesh (which has the largest voter base in the country) opted for a non-incumbent candidate campaigning for progressive economic reform and anti-corruption measures rather than populist, religion or caste-based politics. Both the results of the elections and the manner in which they were conducted demonstrate a shift in attitudes towards the type of democratic system which should be conducive to the development of an increasingly business- and investment-friendly environment. The elections were characterised by high voter turnout, negligible violence and a transparent process.
We believe that investors should view the elections as a very positive development and one that should increase the pace at which government interference in the business sector is reduced. In combination with the stimulatory monetary policy we expect over the course of this year, and despite this weekend’s political distractions, the outlook for Indian equities is, in our opinion, attractive. With corporate earnings expectations for this year having now moderated towards low double-digit growth and equity valuations still at depressed levels, we believe there is currently a very compelling entry point for investors.
Indian growth has slowed as a result of last year’s monetary tightening, and official guidance for the year to March 2012 was cut to 6.9% in the Indian budget announcement. While this rate is below the level of expansion experienced in the last few years, it remains very impressive relative to most developed economies. Furthermore, with inflation now retreating, we expect policymakers to switch their focus to the stimulation of domestic growth this year. Finance minister, Pranab Mukherjee, stated that indications from the first quarter of 2012 suggest that the economy is already turning around.
The chances of an interest rate cut early last week were hampered by the recent rise in the oil price, which resulted in inflation rising from a two-year low of 6.6% year-on-year in January to 7% for February. However, unless there are further substantial increases in energy prices, we believe that the disinflationary trend will resume, allowing the central bank to implement further supportive policies. We continue to expect aggressive interest rate cuts this year. The bank has already shown that it is ready to take action to stimulate the economy; on March 9 it cut the cash reserve ratio by an unexpected 75 basis points to 4.75%. This follows on from a 50 basis points cut announced in January.
Avinash Vazirani is manager of the Jupiter India fund.