Signalling Effect !!!

In an stunning  twist , the contours of discourse in the country has changed  from “ graft & drift”  to “swift & spirited reforms” . Optimism is back in the markets with renewed vigor fuelled by all round buying  by FIIs  . FIIs have poured in close to  USD 3.0Bn+  post the diesel price hike and FDI in retail . Behind all these  glittering fireworks  and smokescreen , there is this seemingly innocuous  question that how could couple of “not-so-far-reaching”  policy actions change the trajectory so quickly.The answer to this lies nowhere, but in the “signalling” effect of these policy actions , much less in its material significance .

Economics is a fascinating subject precisely because of its transitory nature . The most vital ingredient on which it hinges   is also the most fleeting one  i.e. trust and confidence .  Confidence or lack of it could produce completely contrasting results in the economic landscape . One can trace the roots for its cyclical nature to  those ephemeral ones.

The idea behind recent ECB’s all round bazooka ( unlimited bond buying ) is not so much about of quantum or size of bond buying than about sending out confidence . History tells us that such announcement eventually ends up in much less bond buying than if it had not announced one .  So was the case with TARP in 2008 in US . From what it was originally conceived as a bail-out fund , it ended up making some money for the US Govt !!!.   What happened in  these cases is that the confidence generated by these moves effectively negated the need for one such !! . That is the power of signalling effect .

The case is no different in our desi situation as well . Hike in diesel or FDI in retail in isolation are not path-breaking moves  by the Govt . But , coming at a time when the confidence is completely crippled has its benefits  .  While it is easy to find the scapegoat in high Inflation and high interest rates for the deadly slowdown in India ,  digging deeper, one finds loss of confidence stemming from drift and sleaze from policymakers has been at the root of this disastrous slowdown.  What else would explain such a sharp erosion in Rupee which worsened the inflationary pressure ( and thus the interest rates) amidst  otherwise softening commodity prices.  Sudden blitz in UPA thro’ high dose of policy actions is a prescient attempt to stem this  rot and reverse this self-fulfilling degenerating cycle  of confidence .

Such a signaling effect had its desired impact , if one goes by  Rupee’s sharp retrace to  sub 53 (  52.85 to be precisely)  . With rising Re expected to soften inflationary pressures and deficit pressures  going forward  , RBI in all probability will have ample leeway to start the fresh easing cycle from its Oct policy season.  Together , such a trend can eventually reverse the capex cycle so as to get the economy back on  steam  again . It is a magical work of signalling effect !!!

With market’s penchant nature to discount things far in advance, it is no surprise that markets are on roll again , while economy is still on its mend !!!! …Watch out for interesting times…

Happy Value Investing!!!!