Put effect was named on legendary thinker and master of markets Alan
Greenspan, former chairman Federal Reserve, and his desire to make sure
equity markets in the US never fell on a sustained basis.
It was an unwritten contract between Mr Greenspan
and the market, wherein the Fed chairman took out the
downside risk of a market meltdown, and thus encouraged
market players to pile on risk. By implicitly promising
to come in and cut interest rates whenever markets
were in free fall, Mr Greenspan was giving market
players a free put option by protecting their downside.
Most notably, after the dotcom crash of 2000, Mr
Greenspan cut interest rates aggressively to stem
Nasdaq’s free fall and kept rates low for an extended
period of time, as the Fed chairman sought to cushion
the US economy and financial markets from the technology
bust. In fact, many observers blame Mr
Greenspan and this period of hyper-easy monetary
policy for sowing the seeds of the housing bubble.
Many market players also blame the notion of the
Greenspan put for encouraging the excessive risk-taking
and leverage in financial markets that eventually
caused the financial system’s meltdown.
Fed Chairman Ben Bernanke has continued the
Greenspan tradition and tried to use monetary policy
to stabilise the economy and financial markets. He has
gone a step further: he has explicitly targeted equity
markets and made known his desire to see them rise
through the various rounds of quantitative easing.
Now what does all this have to do with India and our
honourable finance minister? I think the reality is that
given how critical healthy and buoyant capital markets
are to reviving the Indian economy, Finance Minister
P Chidambaram will have to conjure up some type of
put option of his own to ensure that equity and debt
investors remain engaged with India.
Why are capital markets so critical? Most policy
makers have identified cutting the fiscal deficit as a top
priority to get the Indian macro story back on track.
Given the difficulty in getting the coalition to accept the
diesel hike and LPG-targeting measures, there are limitations
as to how much the current subsidies and revenue
expenditure can be compressed. We can see some
further measures on fuel price hikes and maybe some
movement on a nutrient-based subsidy on urea; but
with elections only 15-18 months away, there are serious
political costs to any subsidy cuts. There is also intense
pressure on the government to roll out more freebies
through the right to food, free medicines and so on. If
expenditure compression is intensely difficult in the
run-up to an election cycle, higher revenue is the only
way to control the fiscal deficit. Given the government
is simultaneously trying to improve sentiment and
kick-start corporate investment, significant tax hikes
are unlikely to be the path to increase revenues.
The obvious path is to monetise government assets,
be it spectrum, coal blocks, surplus land or public sector
unit stakes. The finance minister will have to do a lot
more than raise ~40,000 crore from spectrum and
~30,000 crore from divestment. We will need to see
movement on selling the SUUTI (Specified
Undertaking of UTI) stakes, strategic assets like
Hindustan Zinc, land with companies like VSNL, coal
block auctions, etc. To enable the government to raise
resources of the required magnitude, the capital markets
have to remain healthy, both to absorb equity
issuance and to enable companies to raise enough debt
resources to participate in these asset auctions.
Capital markets also need to remain healthy to
enable large Indian companies to recapitalise their balance
sheets. While large infrastructure projects are
stuck owing to regulatory issues, most of these project
developers have stretched balance sheets and negative
cash flows. The banking system is increasingly
averse to putting new money to work with these developers
and their projects. Unless the capital markets,
both debt and equity, reopen for these developers, irrespective
of regulatory relief, projects will not progress.
No matter how much the finance minister and his
team de-clog project approvals, without a healthy capital
market and access to equity most projects will not
move. Capital markets are also reflexive, in that access
to capital by itself starts making previously unbankable
projects and borrowers viable. Once a positive funding
cycle commences, it improves sentiment, extends
entrepreneur time horizons and reinforces itself.
We also need buoyant capital markets to fund the
current account. While the current account deficit may
go down from 4.2 per cent of gross domestic product
(last year) to 3.5 per cent in 2012-2013, even this number
has to be funded — and flows by foreign institutional
investors are key. Equity inflows have already
crossed $12 billion this financial year, and this positive
momentum must be sustained.
The finance minister wants to re-establish India’s
long-term growth trajectory, and healthy capital markets
are a key part of the solution.
The only way the finance minister can keep
investors enthused is to continue moving ahead rapidly
with policy moves that need no legislative clearance.
We have already seen a stream of announcements, and
I think the momentum will continue. There is significant
policy low-hanging fruit across sectors, given the
virtual famine of reform in the past few years: revising
investment norms for insurance companies, modifying
the direct taxes code, new banking licences, a project
investment board, and so on.
This finance minister is very investor-savvy, has
conviction in markets, understands the key role capital
markets will play in reviving the Indian economy
and has a sector-specific game plan. It will be foolish to
bet against him. He has the ability to keep the markets
moving, if he can deliver policy action.
Obviously, political risk still exists, and the government
may yet collapse before its full term. We must also
acknowledge that the Congress high command may
still get cold feet and go back into policy denial mode.
However, absent that, Mr Chidambaram is signalling
that he needs markets to remain buoyant and knows
what needs to be done to ensure that they do. A lot of
the policy measures needed to enthuse markets have
little political downside; they just need co-ordination,
better administration and decisiveness, which he can
deliver. This is his version of underwriting the downside
— delivering basic governance and policy action,
enough to keep markets interested and investors
focused on the long term. He cannot allow capital markets
to go into a deep dive and be effectively shut for
new fund raising. If that were to happen, then he has no
workable game plan to get us out of this rut.
As long as the finance ministry can keep pushing
ahead with reforms and keep convincing investors that
decisions will be taken, markets are unlikely to correct
significantly. Given the sharp up-move, the broad market
indices may stay at these levels for some time; but
within these indices one is likely to see significant sectoral
churn. Investors have been hiding in the defensives,
taking them to all-time high relative valuations.
This is now likely to reverse. Most investors continue to
disbelieve this rally: domestic investors have redemptions
and majority of international investors are still
positioned defensively. The pain trade is for this market
to continue to go up, led by the more economically
sensitive sectors.
That is what the country, economy and the finance
minister need.
Greenspan, former chairman Federal Reserve, and his desire to make sure
equity markets in the US never fell on a sustained basis.
It was an unwritten contract between Mr Greenspan
and the market, wherein the Fed chairman took out the
downside risk of a market meltdown, and thus encouraged
market players to pile on risk. By implicitly promising
to come in and cut interest rates whenever markets
were in free fall, Mr Greenspan was giving market
players a free put option by protecting their downside.
Most notably, after the dotcom crash of 2000, Mr
Greenspan cut interest rates aggressively to stem
Nasdaq’s free fall and kept rates low for an extended
period of time, as the Fed chairman sought to cushion
the US economy and financial markets from the technology
bust. In fact, many observers blame Mr
Greenspan and this period of hyper-easy monetary
policy for sowing the seeds of the housing bubble.
Many market players also blame the notion of the
Greenspan put for encouraging the excessive risk-taking
and leverage in financial markets that eventually
caused the financial system’s meltdown.
Fed Chairman Ben Bernanke has continued the
Greenspan tradition and tried to use monetary policy
to stabilise the economy and financial markets. He has
gone a step further: he has explicitly targeted equity
markets and made known his desire to see them rise
through the various rounds of quantitative easing.
Now what does all this have to do with India and our
honourable finance minister? I think the reality is that
given how critical healthy and buoyant capital markets
are to reviving the Indian economy, Finance Minister
P Chidambaram will have to conjure up some type of
put option of his own to ensure that equity and debt
investors remain engaged with India.
Why are capital markets so critical? Most policy
makers have identified cutting the fiscal deficit as a top
priority to get the Indian macro story back on track.
Given the difficulty in getting the coalition to accept the
diesel hike and LPG-targeting measures, there are limitations
as to how much the current subsidies and revenue
expenditure can be compressed. We can see some
further measures on fuel price hikes and maybe some
movement on a nutrient-based subsidy on urea; but
with elections only 15-18 months away, there are serious
political costs to any subsidy cuts. There is also intense
pressure on the government to roll out more freebies
through the right to food, free medicines and so on. If
expenditure compression is intensely difficult in the
run-up to an election cycle, higher revenue is the only
way to control the fiscal deficit. Given the government
is simultaneously trying to improve sentiment and
kick-start corporate investment, significant tax hikes
are unlikely to be the path to increase revenues.
The obvious path is to monetise government assets,
be it spectrum, coal blocks, surplus land or public sector
unit stakes. The finance minister will have to do a lot
more than raise ~40,000 crore from spectrum and
~30,000 crore from divestment. We will need to see
movement on selling the SUUTI (Specified
Undertaking of UTI) stakes, strategic assets like
Hindustan Zinc, land with companies like VSNL, coal
block auctions, etc. To enable the government to raise
resources of the required magnitude, the capital markets
have to remain healthy, both to absorb equity
issuance and to enable companies to raise enough debt
resources to participate in these asset auctions.
Capital markets also need to remain healthy to
enable large Indian companies to recapitalise their balance
sheets. While large infrastructure projects are
stuck owing to regulatory issues, most of these project
developers have stretched balance sheets and negative
cash flows. The banking system is increasingly
averse to putting new money to work with these developers
and their projects. Unless the capital markets,
both debt and equity, reopen for these developers, irrespective
of regulatory relief, projects will not progress.
No matter how much the finance minister and his
team de-clog project approvals, without a healthy capital
market and access to equity most projects will not
move. Capital markets are also reflexive, in that access
to capital by itself starts making previously unbankable
projects and borrowers viable. Once a positive funding
cycle commences, it improves sentiment, extends
entrepreneur time horizons and reinforces itself.
We also need buoyant capital markets to fund the
current account. While the current account deficit may
go down from 4.2 per cent of gross domestic product
(last year) to 3.5 per cent in 2012-2013, even this number
has to be funded — and flows by foreign institutional
investors are key. Equity inflows have already
crossed $12 billion this financial year, and this positive
momentum must be sustained.
The finance minister wants to re-establish India’s
long-term growth trajectory, and healthy capital markets
are a key part of the solution.
The only way the finance minister can keep
investors enthused is to continue moving ahead rapidly
with policy moves that need no legislative clearance.
We have already seen a stream of announcements, and
I think the momentum will continue. There is significant
policy low-hanging fruit across sectors, given the
virtual famine of reform in the past few years: revising
investment norms for insurance companies, modifying
the direct taxes code, new banking licences, a project
investment board, and so on.
This finance minister is very investor-savvy, has
conviction in markets, understands the key role capital
markets will play in reviving the Indian economy
and has a sector-specific game plan. It will be foolish to
bet against him. He has the ability to keep the markets
moving, if he can deliver policy action.
Obviously, political risk still exists, and the government
may yet collapse before its full term. We must also
acknowledge that the Congress high command may
still get cold feet and go back into policy denial mode.
However, absent that, Mr Chidambaram is signalling
that he needs markets to remain buoyant and knows
what needs to be done to ensure that they do. A lot of
the policy measures needed to enthuse markets have
little political downside; they just need co-ordination,
better administration and decisiveness, which he can
deliver. This is his version of underwriting the downside
— delivering basic governance and policy action,
enough to keep markets interested and investors
focused on the long term. He cannot allow capital markets
to go into a deep dive and be effectively shut for
new fund raising. If that were to happen, then he has no
workable game plan to get us out of this rut.
As long as the finance ministry can keep pushing
ahead with reforms and keep convincing investors that
decisions will be taken, markets are unlikely to correct
significantly. Given the sharp up-move, the broad market
indices may stay at these levels for some time; but
within these indices one is likely to see significant sectoral
churn. Investors have been hiding in the defensives,
taking them to all-time high relative valuations.
This is now likely to reverse. Most investors continue to
disbelieve this rally: domestic investors have redemptions
and majority of international investors are still
positioned defensively. The pain trade is for this market
to continue to go up, led by the more economically
sensitive sectors.
That is what the country, economy and the finance
minister need.
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