Indian asset markets were nervous ahead of the Lok Sabha election when the outcome appeared uncertain. With the uncertainty now over, markets have been in a celebratory mood, welcoming the formation of a stable reform oriented government. Such an outcome has previously led markets to do well over a six month period post elections. With the BJP having a clear majority in parliament, hopes are high that the Narendra Modi-led government will acti on the near term challenges, and will carry out major structural reforms to help improve India’s long term growth prospects.
However, the market reaction to the RBI’s recent monetary policy action is a reminder of the significant challenges the government faces. The economy is facing a cyclical slowdown, resulting in a slowdown in corporate earnings growth. The slowdown has been driven by a number of factors, the major one being the lack of liquidity in money markets, on account of a crisis in the NBFC sector. Other factors have played a role as well. Chief among them is the slowdown in government spending ahead of the elections, as well as companies going into a “wait and watch” mode before the elections. This slowdown has been evident in the weakness in auto sales as well as sales of FMCG companies.
Policy intervention, both by the government and the central bank, is needed to reverse the slowdown. The RBI has acted to restore liquidity, with a number of open market operations (OMO) to infuse liquidity and has also injected liquidity through FX Swaps. As a result, the monetary system is now in surplus after a period of deficit. The RBI has also has announced a Rs 15,000 crore OMO for June.
In addition, the RBI has cut the repo rate three times in steps of 25 bps each since February. More importantly, the monetary policy stance has now turned accommodative.
Recognising the extent of the challenges it faces, the government has set up eight high level committees to work on a number of issues, out of which two will focus on growth and employment. The purpose is to coordinate policy decisions and their execution. The government needs to work out policies for a near term boost for the economy, as well as to improve long term growth prospects and employment.
For the short term, the government can help by accelerating spending, especially on infrastructure projects. Secondly, the government needs to infuse capital in PSU banks to improve transmission of monetary policy and boost credit growth. However, the fiscal headroom is limited as fiscal consolidation is needed in order to prevent crowding out of investments.
The global economy has been a worry for a while. the US yield curve has flattened and data from China has been worrying. Fixed asset investment growth is at its lowest since 1999, and trade is a worry with exports declining by 3% in April 2019. Data from Europe has been weak. Trade wars and geopolitical tensions jolting oil prices is yet another risk. However, not all is bad with US unemployment at 3.6 and China’s manufacturing PMI is back above 50. This implies a low probability of a global recession, but the global economy is facing a slowing down over 2019 and possibly over 2020.
In this backdrop, we do expect that on account of policy actions, the economy should recover by the second quarter of FY2019-20. We also expect that recovery will be led by acceleration in investment spending in the economy, first by the government and by the private sector as well. As a result of IBC as well as government and RBI action, banks are in a position to lend again, though the government needs to infuse capital for in PSU banks to sustain growth. A broad based recovery in the economy, especially in investment spending will help a recovery in corporate earnings growth over the second half of FY2019-20 and beyond.
The government in its previous term carried out a number of structural reforms, Insolvency and Bankruptcy Code, GST and RERA being notable ones. It also helped in cutting red tape. As a result, India has improved its ranking in the World Bank’s Doing Business Index to 77 in 2019 from 134 in 2014. India’s ranking on Global Competitiveness Index has also improved to 57 from 71 in 2015.
However, the road ahead is a long one as India needs significant reforms to improve its long term growth prospects. Chief among them would the areas of labour to help realise India’s demographic dividend. India also needs reforms in the land related industries particularly in the agricultural sector. The privatization of PSUs should be another priority on the agenda of the government going forward.
The ruling alliance has secured a majority in Lok Sabha and is likely to get a majority in Rajya Sabha in 2021. This has given rise to hopes that some long delayed reforms like amendments to the new Land Acquisition Act of 2013 could be made. Expectations are not limited to this legislation, but extend to the government being able to push through tough reforms.
We expect that the government may lay out its agenda for the next five years in the first 100 days. However, given that some amount of consensus would be needed, we expect that there will be slow and gradual progress on major structural reforms.
Confidence is a powerful force, the expectations of reforms as well as actions to reverse the slowdown can help rekindle animal spirits among investors, as well as corporate. Against this backdrop, we expect the underlying tone to remain positive. However, given the recent rally, as well as near term weakness in the economy, we expect that markets will pause for a breather, but are likely to rally again towards the second half of the year. Given the expectations of a pickup in investment spending and economic reforms, we believe that banks, capital goods, cement and autos are likely to do well. Mid caps are likely to perform well as the willingness to take on risk is higher.
Rajiv Singh is CEO-Stock Broking at Karvy Stock Broking.