Market sentiment in the near term will be influenced by the outcome of the elections. Though the markets couldn’t predict the outcome in the 2004 and 2009 polls, they got lucky in 2014. In 2004 as well as in 2009, the unexpected outcome resulted in a significant movement in the market. Today, the market is pricing in a reform-oriented, stable government pivoting around one national party, and so, there will be material move on the day of the poll result if the actual result ends up being different.
In 2004, the market corrected by more than 15% on result day but thereafter rallied on strong growth. In 2009, the market went up 20% on result day but then remained subdued due to tepid growth. In 2014, the market moved up in anticipation of a stable government well ahead of the polls. The post-poll market performed moderately in nominal terms but better in real terms.
From a fundamental point of view, earnings growth in financial year 2019-20 could jump due to corporate-focussed banks, generic pharma companies and companies with a presence in Europe.
From the headline point of view, GDP growth in the third quarter of FY 2019 slowed to 6.6%. Auto sales in February were down by more than 7% and the auto sector is cutting production to manage higher inventory. Fast Moving Consumer Goods (FMCG) and consumer durable companies are hinting at a demand deceleration. Tractor firms are talking about deceleration in the rural economy. GST collections are below the budgeted run rate. So why is the market ignoring signs of deceleration?
That’s because these signs point to a slowdown in growth and not negative growth. India is still the fastest growing major economy. The below potential growth is a function of multiple factors — formalisation of the informal sector due to disruptive reforms like demonetisation and the GST has changed the business model, resulting in an inevitable slowdown.
An overvalued rupee in the last few years allowed China to dump goods, putting tremendous pressure on Indian companies and our FY’19 trade deficit with China is $63 billion. Growth also suffered as some of the judicial interventions resulted in the closure of iron ore mines, cancellation of coal mines and shutdown of plants over environmental issues. In the last few years, the government pursued the path of fiscal prudence which, combined with a tight monetary policy, pushed growth below potential.
The inflation targeting framework of the RBI required keeping liquidity in deficient mode. Shortage of liquidity resulted in restricted credit flow to support higher growth. The market is now factoring in that the liquidity situation will improve post-election and the RBI will keep appropriate liquidity to support higher growth. The cost of credit was relatively higher as the RBI battled inflation and inflationary expectations. If the GoI is borrowing at more than 4% real interest rates, Small and Medium-sized Enterprises (SMEs) are borrowing at double-digit real interest rates.
There are very few countries where nominal interest rates are as high as real interest rates in India. Higher real interest rates have brought inflation down from double digits to single digit but have kept growth below potential. Market is expecting sharp rate cuts to bring down cost of borrowing. The transmission of credit was restricted to sectors such as SME, real estate and infrastructure, especially from PSU banks which were placed under the PCA framework. Post the IL&FS default, most of the Non Banking Financial Companies (NBFCs) scaled down their lending, creating a credit squeeze resulting in below potential growth. The market is pricing in that PSU banks will get adequate capital from the transfer of reserves from the RBI. Besides, the improved credit flow post capitalisation of PSU banks will push growth to its potential.
The market is hopeful that in the days to come, growth will be supported by appropriate credit with better liquidity, lower real interest rates and better transmission. A fairly valued currency will keep under control the Chinese dumping of goods. A stable government will improve ease of doing business and ensure minimum government and maximum governance. The path of fiscal prudence will be maintained by raising resources through strategic divestment and asset monetisation. The monetary policy will become more accommodative as inflation remains subdued. All this will result in better growth in the future. The task is cut out for the government, RBI, judicial authorities, bankers and entrepreneurs to push growth back to potential level.
Over the years, India has seen many elections and governments. While on the one hand markets have moved higher with economic growth under various governments, on the other hand we have been left behind by all our peers over the last seven decades. Japan, China, South Korea, Taiwan, Thailand, the Philippines, Indonesia, Malaysia, Singapore have left us behind in economic growth by adopting more market-oriented policies. However, we haven’t become a disaster like Zimbabwe and Venezuela by adopting populist policies that lead to bankruptcy.
Sound economic policies have lifted countries out of poverty and changed their growth orbit. It is a self-sustaining cycle which creates higher growth, which in turn attracts investors providing capital to support growth. Let us hope that India remains on the path of rapid economic growth by following sound economic policies.
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