Volatility is set to increase in Indian shares as political problems hobble policymakers from taking hard decisions to remove roadblocks and pave the way for investments in crucial sectors such as infrastructure.
The government was forced to roll back a modest increase in railway fares last week, highlighting the fractious coalition politics that has brought New Delhi to a standstill in pushing much needed reforms to keep the economic engine ticking.
India's railway network is the world's largest, carrying 20 million people each day over 64,000 kilometres of tracks, a large chunk of which was laid by the British more than a century ago and needs urgent replacement and modernisation.
The state-owned railway is also a vital cog in ferrying freight across the vast country. Yet political grandstanding with an eye to short-term vote banks rules the roost, putting in jeopardy the longer term outlook. The railway minister who proposed the passenger fare increase — which was the first rise in a decade — was booted out by his party in the ruling coalition within days, and Prime Minister Manmohan Singh could do nothing about it.
"The rollback was an embarrassing setback for the government and its ability to pursue reforms," said equity salesman Rahul Doshi. "It will be an overhang on the market — you can forget big rallies."
With the Congress party in disarray after being routed in provincial elections, including in Uttar Pradesh, and the main opposition Bharatiya Janata Party unable to make headway, there could emerge a ramshackle coalition of powerful state groups.
"Markets abhor political uncertainties," Doshi said. "There will be more volatile price movements."
The top-30 Sensex skidded more than two per cent after the rail fare rollback, before recouping partially the following day. The index ended down 0.6 per cent on the week at 17,361.74.
Oil Minister Jaipal Reddy said on Friday the government would have to raise prices of petroleum products to help bridge the losses being suffered by state refiners for selling diesel, kerosene, cooking gas and petrol below the cost of imports and taxes.
However, it would be difficult for the minority Congress party to do this anytime soon against the wishes of its coalition parties, and the opposition waiting for an opportunity to put the government on the mat during the budget session of parliament that runs till May.
For all the shortcomings, the silver lining is the flood of global liquidity. Data from the Securities and Exchange Board of India shows foreign funds bought shares worth nearly $9 billion (Dh33.1 billion) since the end of 2011 — a year when there was net outflows of $500 million.
"Emerging markets like India continue to be one of the choices which are pretty high up on people's list," says Cameron Brandt, director of research at EPFR Global.
But this money is mostly going into large diversified global emerging market funds that target big index-linked companies, leaving out the second and third-tier stocks.
There is also a perception that consumer spending would pick and help companies improve their performance, despite the government's policy paralysis and lack of leadership.
"We believe growth will indeed pick up in India over the next one to two quarters and that the equity market will start to reflect these prospects in the coming months," Goldman Sachs said, upgrading Indian stocks to "marketweight" from "underweight".
Morgan Stanley said market valuations were attractive in India, earnings revisions have bottomed out and interest rates are likely to drop.
"We continue to like discretionary consumption and technology stocks and our current emphasis remains on stock picking," it said in a note.