By Mr R Venkataraman, MD, IIFL Securities Ltd
The opening lines of “A Tale of Two Cities” summarises the state of Indian stock markets and economy aptly. The stock market trading at highs is having the best of times whereas the faltering economic growth is facing the worst of times. It is the epoch of belief that Indian economy will hit the USD5 trillion mark and how it will get there is the epoch of incredulity. It is also the season of hope that worst is behind us and season of darkness especially on various fronts like employment. And so on.
During my recent travels and meetings with different types of investors and corporates of all sizes – the common question is “Why is the market going up when the economy is struggling?” And in spite of the Sensex being above the 40,000 mark and the Nifty above 12,000, no one seems to be happy. In the past, such psychological levels has been celebrated by releasing balloons from top of stock exchanges and TV anchors would be at their creative best to celebrate these milestones. The low happiness quotient is because of corresponding low participation in the wealth effect.
A few stocks popularly known as Hrithik
stocks in WhatsApp groups contribute most of the Index gains. These stocks don’t form the bulk of portfolio of most investors. The Nifty Smallcap and Nifty Midcap indices were down 9.5% and 4.3% last year. If you remove Hrithik
stocks from Index calculations, then you are left with an Index, which is much lower and truly reflecting the current state of the economy.
The markets are rising because of the robust FII flows, post corporate tax cuts in end September. In nearly four months since the tax cut announcements, FII net inflows have been about USD 8 billion in India equities. Most of the inflows have gone into the usual suspects and that explains why the Nifty levels are where they are.
Domestic flows have also been healthy. AMFI has been reporting a steady collection of about USD 1billion in equity SIPs. This reflects the maturity of the retail investors and points to the fact that mutual funds have now become a preferred investment vehicle for retail.
Global economy is slowing down and central banks are adopting a dovish policy stand. There is an increased hope of trade pact between US and China. As a result, global markets are rising and the Risk On trade is back. India is also a beneficiary. Nifty has broadly delivered 12% gains last year. Developed markets have performed significantly better - S&P 500 was up 29% and European markets are up around 23%. Emerging markets are a mixed bag. Russia is up 29%, Brazil is up 32%, Turkey is up 25% and China is up 55%, whereas Mexico and Philippines were up 5%. Many of these have outperformed India on local currency basis. Second quarter results were not a disaster. However, Nifty trades at a premium to other EMs on a 12-month forward basis, with falling ROE, which is concerning.
The pain in the economy has its origins in September 2018 when IL&FS defaulted. In the last 12 months, the Indian financial system has withstood multiple arrows - IL&FS, DHFL and ADAG defaults, debt problems of Zee Group, corporate governance issues in CG Power, Coffee Day and so on. All this has a cascading impact on domestic liquidity flows. We are in a situation where systemic domestic liquidity is high, but transmission is low. In spite of rate cuts, credit flow and rate cut transmission is not happening. RBI’s focus must shift from rate cuts to rate transmission and making credit available to different parts of the economy.
Some observers are hoping that private sector capex will help recover the economy. In my view, private sector capex is at least 24 months away. A large bank has shut down its project finance department, and that reflects the appetite or lack of it for corporate lending. All banks are focussing on retail. Fresh capex proposals are far and few in between. The good thing about project finance or corporate loans is the Essar judgment. This is a watershed moment and we will look back and say that 2019 was the year when corporate lending in India changed for the better.
The government clearly needs to do some heavy lifting and spends. Fiscal deficit, which is tracked by most economists in developed nations should not become a deterrent in a developing country like India where growth is a bigger problem than inflation and deficit. The other engine remains consumption. This can be triggered by Direct Tax Code implementation and rate cuts to make more money available in hands of the common man.
We are passing through the last phase of pain that began with demon, followed by GST implementation and then IL&FS defaults. We believe that economic indicators will start looking up over the next two quarters. This cannot happen by merely hoping. The need of the hour is infra spending and personal tax changes. To fund this, India needs big ticket privatization. PSU divestment is a low hanging fruit. Pluck it before global liquidity runs off. Structural changes are required to put India back on track to target USD 5 trillion economy.
The stock markets may change directions many times over the next six months. The Indian economy will also hopefully change its direction for the better. All eyes will now be on Budget 2020 in February.