Friday, August 2, 2013

The limits to "talking up" the markets

Lots of activity on economic reforms front in recent weeks coming from New Delhi. The Finance Minister has led the way in talking up the markets with high-profile visits to global capitals. Just in the last couple of days the Union Government has liberalized the caps on foreign direct investments (FDI) in telecom, defence, and insurance sectors, and relaxed the conditions of retail trade liberalization. Further, there are also attempts to kickstart the disinvestment and privatization process.

It would be very naive to believe that any of these measures will do much to address the deep-rooted structural problems facing the Indian economy. Even if the Indian industry and even influential opinion makers feel that the second round of reforms have been re-started, the Finance Minister and his officials are smart enough to realize that this is just "damage control".

Their hope would be that these measures would reverse the process of erosion of confidence that had gripped investors and businesses over the past couple of years. It would revive the animal spirits and boost investor confidence so that private investments, especially by foreign capital, will increase, and capital flight will be reversed. This, in turn, would help bridge the country's unsustainable current account deficit. In other words, this is just "talking up" a weak and uncertain market.

But as a holding measure, it is very important. In terms of global investor confidence, India appears to stand on a slippery slope, maybe even a precipice. The immediate trigger may have less to do with fundamentals than a stream of bad news about the Indian economy, amplified by global factors, which have shaken investor confidence and business sentiments. Foreign investors are taking flight, prompted also by events elsewhere. The rupee has been falling. Bond yields have surged precipitously. And now the equity markets have joined the downward slide. In the circumstances, a self-fulfilling negative cascade can always be round the corner. "Talking up" the business sentiment with high-profile expectations-shaping measures is the urgent need of the hour.

But didn't someone say that "talk is cheap". It can backstop an imminent crisis, but will only kick the can down the road unless supplemented with more fundamental reforms. I'll have something to say about that in the days ahead.

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