FIIs' research reports on political risk in India is akin to paid news

Foreign Institutional Investors (FII) have started to predict the outcome of 2014 general election in the garb of evaluating political risk.

American investment bank Goldman Sachs and the Asian giant CLSA while trying to assess the Indian stock market prospects for the upcoming calendar year has taken cognizance of the fact that it is an election year and has tried to factor in a change in government. In their assessment of current political milieu, the fall of the United Progressive Alliance (UPA) is certain while the ascension of National Democratic Alliance (NDA) led by the irrepressible BJP leader Narendra Modi is a clear possibility. Should they be taken seriously?

Investment banks are in the business of selling financial products to their clients. There is no country in the world where businesses are insulated from politics and political climate. Governments in power can alter tax rates, introduce new business regulations, can open the economy to more competition and hence have an enormous power to affect profitability of companies. And indeed investors demand an evaluation of all risks that includes outcomes of elections in democratic countries. Thus it is not surprising that well known investment banks are venturing into analysing political risk in India.

Predicting winners and losers in various sectors of the economy as well as individual companies on change of government has been prevalent for many decades. And in the past, an accurate forecast has provided a king size return on investment for individuals as well as institutions. Thus investment banks often analyse and provide information for clients to jazz up their investments months before a general election. Recently in the United States, as re-election prospects of president Obama improved, institutions were busy hazarding a guess on likely winners and losers in pharma sector as the result of implementation of Obamacare. And even in our own country, the stock market greeted the victory of UPA and the thorough defeat of Left parties in 2009 by hitting the upper limit circuit break for consecutive days. 

There is no doubt that most Indian as well as foreign investors are yearning for a change in government following the dismal performance of UPA II on managing the economy. They see Narendra Modi as a business friendly politician who can foster change and introduce much sought after reforms. They want a clear break from the UPA II regime under whose watch business regulations have been imposed whimsically, retro taxation has become vogue and various ministries moving from the dreaded permit raj to an equally hideous clearance raj.

Research report

Unfortunately these investment banks have no credibility and more often, they pedal what their clients would like to hear as a research report that is not based on solid information and credible sources. Their doublespeak and loss of face came during the internet bubble that burst in year 2001. Investigations found that research departments of many investment banks were recommending internet firms to investors as pioneers in the industry and are likely to be path breaking profitable companies. Behind the back of same investors in e-mails to colleagues, they were mostly calling the same companies as junkies.

And the 2008 financial crisis nailed the last nail on their coffins. The research reports put forth by these supposedly reputed investment banks were so hollow and shallow that investors later came to frown upon them. Once crisis hit the United States’ economy and spread like a wildfire across the globe, most of them became zombie firms and either needed government bailout or were forced into merger with larger banks. Lehman Brothers went bankrupt. Bear Stearns and Merrill Lynch were compelled by the Central Bank of United States to merge with big savings banks. Goldman Sachs and Morgan Stanley survived after converting themselves into bank holding companies. Otherwise, they too risked bankruptcy and demise.

Even on the Indian economy, most investment banks have gone horribly wrong in their prediction. Goldman Sachs forecast of Indian economy in financial year 2012 and 2013 has been inaccurate by a wide margin as were that of other financial institutions. All of them failed to see the rapid currency depreciation that our country faced only a few months ago. Moreover, like our own finance ministry revising forecast every three months, these investment banks too were issuing a revised forecast every two months with downgrades of Indian economy. Vagaries of Indian economy are unpredictable with a large informal sector, an agricultural sector that is heavily dependent on a perfect monsoon and a parallel economy whose size can only be guessed by pundits. Hence it is unlikely that anyone can get an accurate economic growth forecast, leave alone the sages at foreign investment banks.

Research reports from investment banks are akin to paid news before an election. FIIs’ indeed have completely lost their credibility and it will take another decade or so with spectacular and precise research to regain their voice with investors. It is best for governments and politicians to ignore them. And investors too must treat them with caution lest they incur losses on their investments.

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