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Indian stock surge doutful guide

The UPA's positive showing against the National Democratic Alliance (NDA), based around the Bharatiya Janata Party (BJP), banished for the moment fears that the Lok Sabha (lower house of parliament) elections would produce an unstable if not internally fractious government and increased the prospect of successful legislation for economic reforms. Congress alone increased its representation from 165 to 205 seats, and with its allies inside the UPA will have 262 members of parliament, or nearly half of the 545 seats.

Indian stock surge false guide to economy
By R M Cutler

MONTREAL - The surge in Indian stock prices that followed Prime Minister Manmohan Singh's election victory highlights how equity markets and the real economy can sometimes appear to inhabit different worlds, at least for a while.

The benchmark BSE Sensex 30 index in Mumbai jumped 17% on Monday following the decisive general election result for the Congress party-lead United Progressive Alliance, the broader-based Nifty index also soared over 17%, and the rupee strengthened a remarkable 3.2% on Monday alone, to 47.9 per US dollar from 49.4.

The strength of Monday's gains on the Bombay Stock Exchange (BSE) was such that trading was twice halted by trading circuit-breakers before being suspended for the remainder of the day, closing at 14,284. The performance brought the indices up to about 17 times the leading price-earnings ratio.

Yet just over 13 million shares changed hands in Mumbai on an exchange where the average volume is 30 times that. This is the mark of intensive short-covering - traders covering their bets that share prices would fall - as the days prior to the weekend announcement of the Lok Sabha results had been rife with rumors of electoral stalemate.

Volume jumped in subsequent days, but without share prices doing likewise. On Tuesday, the Sensex closed almost unchanged, on Wednesday it was down to 14,060, and Thursday an hour after the open it was down to the 13,900 range.

Under that level, the next support is in the 13,300-13,700 range. A decline to test the 13,200-13,300 support is not at all unlikely in light of the Sensex's recent excessive volatility. Below that, there is a firmer support in the high 12,700s. That said, the BSE mid-cap and small-cap indices continue to rise, while the Nifty followed the Sensex.

Nor did the stock exchange reaction indicate a vote of confidence in the new government by foreign institutional investors (FIIs). Overseas funds put US$17 billion into the Indian markets in 2007 but sold over four-fifths of that amount in 2008. This year, FIIs came back into the Indian market beginning in March, when the Sensex began its march up to current levels, with a gain of about 75% from the spring low in the 8,000s (see India's economy in junk mode, Asia Times Online, January 15, 2009).

The Times of India, however, attributed the post-Monday stock declines to FIIs getting out of the market, especially from the construction and real estate sectors. Meanwhile insurance companies, which are required to maintain a particular debt-to-equity ratio, had to sell because the rise in stock prices unbalanced their portfolios in favor of equity, and they needed to re-equilibrate to the given ratio.

The market's short-term performance is based on nothing other than the expectation that Prime Minister Manmohan will be able to pick and choose his parliamentary allies, rather than having them pick and choose for him. Manmohan's position has strengthened further since Monday, with the UPA receiving written support from two parties from Uttar Pradesh state, the Bahujan Samaj Party and the Samajwadi Party, the latter of which will give its support from outside the government (that is, it is not seeking ministerial positions).

Together these two parties will provide 44 more seats, with an additional handful of small parties (some with only one seat) also endorsing the coalition, to bring its total to over 310. The government, which is expected to take the oath of office on Friday, is therefore well placed to push through economic reforms and the sale of state assets that will help pay for government projects if not actually to promote economic growth.

The government is likely to implement an economic stimulus package soon after taking office, increasing public investment in infrastructure projects and also giving interest relief to farmers who repay loans on time. Earlier stimulus policies begun last autumn helped to promote the short-term up-tick in economic activity preceding the recent elections and may well have assisted in the victory (see Indian stocks give poll cheer, Asia Times Online, April 9, 2009).

An expansionary fiscal policy, however, would widen the budget deficit, which might be offset by the government's sale of stakes in state-run enterprises. With the near-global recession also holding back external demand, the country's rate of economic growth may fall to 6% or lower in the current year, down from 7% in 2008 and 9% earlier in the decade.

That could help hold back share prices. Major brokerage houses, also recognizing that reality will come back into the frame as the election euphoria fades, are not predicting the Sensex to close out the year much above 15,000.

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