The COVID-19 pandemic exposed India to the vicious cycle of fiscal expansion, central bank accommodation, unabated foreign portfolio money, and cheap systemic liquidity. This runs parallel to supply chain bottlenecks, weak credit offtake, and sub-optimal consumer demand.
The situation is all-encompassing, given the multiplicity of economic cycles in India. As a result of this complex play among economic variables within the capital market space, it is often impossible to decipher the true market sentiment in an economy of India’s stature.
The primary reason behind this fragmented understanding is the fact that India has low capital market participation, and financial literacy, which is essential in the development of a mature capital market. Therefore, for a layman, every market participant (investors, issuers, governments, and consumers) has its own individual agenda, and operates in silos with no apparent relationship. Consequently, there is a need for a dependable India capital market sentiment index that can potentially measure prevalent market sentiment in real time. As standardised sentiment gauges, these indexes are in the form of simple trend lines that automatically adjust as per the evolving state of the economy, reducing complexities.
Traditionally, with its relatively small and protected capital market, India ensconced itself from the vagaries of global capital flows — never making a case for sentiment indexes. This is because India has fixed limits and sub-limits on foreign ownership of securities, covering the corporate bond as well as government issuance market.
While these limits restrict Indian capital market’s foreign exposure, there are considerable repercussions on the development of India’s currency as well as its overall derivatives market. An often-overlooked fact also pertains to the difficulties faced by foreign portfolio managers in assessing a versatile yet complicated Indian market.
Nevertheless, as a systemically important economy, India’s weight in global capital movement will only rise, and restrictions will increasingly lose their importance. This is true given the fact that by early next year, India may enter global bond market indices such as the $250 billion AUM JP Morgan GBI, and possibly the $2.5 trillion tracking Bloomberg Barclays GAI.
At the same time, India has also started discussing its intention concerning capital account convertibility (CAC). Not without reason, according to Morgan Stanley, India will see bond inflow to the tune of $170 billion over the next 10 years. The bank also estimates that there will be a spill over effect on other segments of the market, including sub investment grade as well as equity.
Given these, a sentiment index that can potentially read the market’s prevalent mood is a requirement. Integrating disparate variables such as long- and short-duration yields, inflation, PE ratio, and auto sales, among others, a machine learning tool can cut the noise, and determine the mood of the capital market.
The factor analysis integrated model can deliver an index that is both comprehensive, and intuitive. Such a special purpose index is a need of the hour, and more such indexes can be developed as the market matures. Preliminary results have shown that such an index can have a 94 percent correlation with India 10-Year G-Sec yield (Figure below).
A further case for such an index is made by the record growth showcased by the dynamic mutual fund industry, which has successfully transferred India’s dormant capital into its capital markets. Managing over $496 billion in assets, the mutual fund industry’s growth has been a function of public trust, and the resultant access to savings, otherwise consumed or parked as fixed deposits with banks. This has brought previously disinterested sections of the society into the purlieu of active capital market management, exposing them to macroeconomic factors potentially impacting their money in real time. A sentiment index, therefore, provides such new market participants with an effective tool to track the complex world of economics.
It is anybody’s guess that this is just a start, and that India’s steady economic rise will only bring in more capital from both domestic as well as foreign sources. Hence, it is important that tools are made available that can seamlessly deliver the pulse of the market to all participants at any given time.
With further advancements in machine learning, and the introduction of more variables such as Environment, Social and Government (ESG), we are confident that the applications are endless. As the world of investing increasingly incorporates Artificial Intelligence (AI), sentiment indexes will also pave the way for electronically-tracked passive funds, future-proofing India’s capital markets.
This is the future of investment management, and India must be ready to handle the complexities that come with ‘never seen before’ global capital inflows.
Karan Mehrishi and Birabrata Panda are economists, specialising in monetary economics and fixed income.
Views are personal and do not represent the stand of this publication.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
