Risks are rising in current market rally

The BSE Sensex convincingly pierced the resistance level of 11,000 last week, ending the week at 11,465 for a weekly gain of 273 points. Reliance contributed about a fifth of this (53 points), followed by Hindustan Lever (25). The pervading feeling, after the halting of the US interest rate hike cycle, is one of general optimism. This, however, ignores multifarious threats posed by a variety of factors.

The current rally, which ought to start petering out in the coming week or so, should be taken as an opportunity to get lighter. As the saying goes, he who fights and runs away shall live to fight another day.

One of these risks is the failure of the WTO round of negotiations. This would affect global trade, responsible for a good bit of global GDP growth. It has affected, or delayed, the chances of three Indian banks, State Bank, Bank of Baroda, and ICICI Bank, to open branches in the US.

In India itself, our commitment to freer markets seems to have become shaky. The RBI is questioning the wisdom of a government policy allowing 100% foreign investment in certain sectors of financial services. It wants a policy debate on this. This would, sadly and unnecessarily, put a spoke in the plans of some entities, such as MCX and the BSE, to bring in foreign investors. Should the RBI have bouts of paranoia, surely a better way would have been to permit foreign stakes upto a certain percentage limit - whatever it is comfortable with -  and allowing a higher stake after the debates are concluded.

But in India we still see ghosts outside our window. We believe that we just have to open it a bit for them to enter and traumatise us. We would rather suffocate in fetid air brought on by closed windows rather than usher in the freshness of competition and efficiency!

We see this also in the continued pumping in of good money after bad into public sector undertaking, many of which are basket cases.

In the past three years, the government has invested some Rs 472,000 crore in the public sector. Of the 273 state-owned units, only 143 made profits whilst 73 were chronically loss-making. Now contrast this generosity, induced only by the mindset of an irrelevant political ideology, with the stated lack of resources for things like infrastructure, education or even police uniforms!

Good money is thrown after bad in these chronically sick companies, primarily to save jobs. Had the same money been used instead to create new jobs, many more would have been created and the sick units could be sold to raise fresh resources and to stanch the financial drain. After 10 years of reform, unemployment figures (as registered) have fallen from 40.5 million to 39.3. However, this is an abysmal performance! There would be 100 million new entrants to the job market in the next decade. We have to stop protecting jobs in unviable companies by throwing good money after bad. Instead, we should create an environment that allows for growth in an interdependent world.
Not one in which we see ghosts lurking outside every window.

In the telecom arena, the department of telecoms has veered around to the view that spectrum should be available at a price. The opposing view was that spectrum should be treated as a ‘common’ resource and available freely for public use, since auctioning a resource leads to its hoarding. Technologies are now available for the sharing of spectrum and so, if spectrum is to be auctioned, DoT and the Telecom Regulatory Authority of India (Trai) should assure two things. First they ought to establish and help develop a market for spectrum trading. Secondly, they should ensure that if spectrum is sold, it does not give the buyer squatting rights - that is, the payment entitles the buyer to use but not to own it. So if a failed operator is bought by another, DoT would have the right to refuse transfer of spectrum rights. It is the shortage of spectrum that is holding back the faster growth of telcos.

BSNL is planning to invest some 80% of its planned investment of Rs 14,500 crore on expanding its GSM network by over 60 million lines. It may raise some Rs 2,000 crore debt and finance the rest through cash flows.

Coming back to global risk factors, the growth of the world’s largest economy, the US, is what is keeping the bulls elated. This, in turn, is based on the propensity of the US consumer to spend, which he does in excess of his income, comforted by the fact that his property has gone up in value as have his equity investments. The results of  Wal-Mart for the last quarter are disturbing. Not only is it reporting its first fall in quarterly profits in 10 years (thanks to mismanagement of its expansion into Germany from which it is now exiting) but, more disturbingly, it shows that sales growth in US stores at least a year old has fallen from 4.7% to 1.7%. This portends badly for US economic growth.

The market mood has been buoyant but the presence of too many dark clouds poses a risk and it may be safer to get lighter. The rally can continue a little more but the risks are high.