Rattled market participants have attributed the stock market mayhem on Wednesday to a multitude of short-term factors — algo trading, Minimum Alternate Tax (MAT) issues and even disappointment with the slow pace of reforms on the Modi regime’s first anniversary. But none of these reasons stands up to close scrutiny. Algo traders are by their very nature followers and not initiators of trends. The MAT scare is fizzling out after a recent clarification from the finance ministry that it involved a sum of just ₹602 crore. That this was a symbolic sell-off to express displeasure with sluggish reforms is hard to accept as it occurred on the very day the Lok Sabha passed the GST Bill. The reality is that with Indian markets delivering a 51 per cent gain (in dollar terms) since 2013, FPIs have legitimate reason to take some money off the table. No one should be surprised if they do so now.
Macro developments have provided the immediate trigger for this profit-taking. An unexpected rebound in oil prices and a spike in European bond yields have put global portfolio managers on tenterhooks about an imminent rise in global interest rates. Rising rates can cause severe damage to the sizeable fixed income portfolios held by these investors; they also weaken the fundamental case for owning equities. Yes, India has been hit more than emerging market peers by this bout of selling, but there are rational explanations for this. With the sustained bull-run taking the Nifty’s price-earnings multiple to 21 times by end 2014, India was beginning to look decidedly pricey relative to its Asian peers. The premium valuations, until recently, were justified by hopes that India’s economic revival would soon accelerate, lifting corporate profit growth to 14-15 per cent for FY15. Such projections are looking decidedly shaky after three consecutive quarters of weak corporate earnings. March quarter numbers have reaffirmed fears that the dodgy global outlook and commodity market rout may have a greater negative impact on corporate profits than previously thought. This calls for a de-rating of India’s stock multiples and a re-balancing of portfolios. India’s flatlining market so far in 2015, even as emerging markets such as China (up 30 per cent), Brazil (up 14 per cent) and Russia (35 per cent) have soared, suggests that such a rebalancing by global investors is already under way.
Against this backdrop, there is no reason for policymakers to get unduly alarmed by recent market gyrations. Economic reforms, however bold, cannot immediately turn around corporate fortunes. Domestic investors on their part should be thankful that FPIs decided to re-assess their bets before stock prices could enter the bubble zone. Domestic households have only recently begun to re-allocate money to equities after a long hiatus. And their confidence in the stock market is still far too tenuous to risk a repeat of the 2007-08 episode, when the Nifty’s multiple rose all the way to 27, before the global crisis administered a rude reality check.