The government should take bold steps in addressing problems related to fiscal deficit, current account deficit, inflation and slowdown in corporate investment. This is the only route to improve market sentiment, says Nomura Equity Research

On the balance, Nomura expects the market rally to fizzle out in due course of time, primarily because the global liquidity glut would likely push up global commodity prices as well, which would worsen India’s twin-deficit problem and raise inflation expectations across the board.

The government policy in India and abroad is fuelling the current rally. The government is defensive because of Coalgate. It has been bolder with respect to the diesel price hike and the opening up of FDI in multi-brand retail, civil aviation and power. The Federal Reserve’s QE3 (third round of quantitative easing) policy is also brave. The ECB’s OMT (outright monetary transactions) lowers financial risk. The rally in markets could also be followed by a rally in the rupee if the capital flows come in strong on improved market sentiment.

Nomura predicts that the market may rally in the short-term, given the facts that dedicated investors are mostly defensively positioned; and Nomura’s feedback from ‘long-only’ investors suggests an across-the-board underweight position on India.

Nomura’s market predictions for the medium term include: (a) It suggests buying banks, real estate and metals as insurance against a beta rally; (b) It thinks that problems besieging the infrastructure sector have not been sorted out in the least, as yet; (c) Nomura feels that inaction of the past few years means that a quick turnaround in the investment cycle would be close to impossible; (d) Nomura thinks that the window of reforms would close in about a couple of months with key impending elections in the states of Gujarat and Himachal Pradesh.

Nomura’s predictions are in the light of the three key overhangs on the economy in India which include:

(a) Fiscal deficit – diesel price hike of Rs5 per litre is insufficient to rein in fiscal deficit. This problem is far from over until the next Union Budget;

(b) Current account deficit – with greater liquidity and a weaker dollar fuelling the rise in global commodity prices, the trade deficit would likely come under further pressure in the coming months. Improved domestic market sentiment may boost FII inflows in both debt and equity, leading to a short-term fix in balance of payments;

(c) Inflation – the potential strength in global commodity prices also means that inflation is likely to surprise negatively in the coming months.

Government leadership is required in policy-making with respect to:

(a) investment slowdown to be addressed, which is due to issues hampering infrastructure and corporate capex; and

(b) commitment to fiscal rectitude—important in the context of general elections in 2014. The government should be cautious on its policy towards subsidies.