Over a one year period, India’s macros have improved despite the government not doing anything substantial for the same. Fiscal deficit as percentage of GDP has come off from 4.5% levels to 4.1% levels helped by fall in global crude oil prices and cut in plan expenditure. Current Account Deficit has come off on falling oil imports despite export growth being negative for last fiscal year. CPI inflation has come off on the back of demand slowdown on both consumption and investments and on the back of soft global commodity prices. Capital flows have been robust on the back of cheap global liquidity and this can go out anytime if economy does not deliver this year.
Global bond bubble bursts are a threat to capital going out of India if Modi government does not deliver to expectations. Read our analysis on “Global Bond Bubbles and its Impact on India”
Expectations drove Markets
The rally that started for the Equity markets when the Modi led BJP Government was expected to come in power continued when they actually came into power but has fizzed out in May 2015.
There were many global reasons that were responsible for the rise and fall in the levels of Sensex and the Nifty in a period of one year including cheap Central Bank liquidity. The interesting point to understand or to study is the steps that the Government has taken in the last one year to help in improvement of the economic conditions to drive the corporate earnings growth. The corporate earnings growth has not picked up pace and especially in the last two quarters of FY 2014-15 it has been dismal. Read our May 2015 Monthly Market Analysis on Corporate Performance. Has the Modi Government taken steps or any initiative to contribute to a favourable investment climate, motivate corporate earnings growth, simplify tax structure and similar such things?
First let us take a look at the economic conditions that were present when the BJP Government was elected with majority. Secondly what is the economic environment in the current scenario and what has the Government done if any of the economic parameters have improved for the better. Even though it is unfair for the Government to be judged in its first year of operation to deliver on economic growth it is interesting to note the changes that have taken place in the same time period.
Inflation as indicated by the Consumer Price Index was hovering around 8.6% levels in the month of April 2014 and currently is marginally below the 5% level. CPI inflation printed at 4.87% for the month of April 2015. Core inflation has been at levels of below 5% for the past few months. The drastic fall in the crude oil prices has contributed to the decline followed by softening of food prices in the last one year.
Food inflation has come off from double digit levels and is at levels of 5.11% as of April 2015. Food inflation still remains a risk and is out of the control of the Government in case monsoon is insufficient or any other factors becoming unfavourable. The Government does not seem to have contributed to any effort for reducing the inflation as none of the factors that drove down inflation expectations are in its control.
The INR traded at levels of Rs 60 per USD in the month of May 2014 and currently trades at a level of Rs 64 per USD.
The currency has depreciated 6.7% in the last one year and has been resilient against the USD with other emerging and developed market currencies depreciating much more in comparison.
The expectations from the BJP Government has fuelled investments in India which continues to keep the INR relatively strong in comparison. FII’s have pumped in USD 45 billion in debt and equities in the last fiscal year.
The Current Account Deficit has been contained at levels of 1.3% of GDP in the last one year and the crash in crude oil prices by 50% has been the main reason for it. The fall in crude oil prices has benefited the economy that depends on crude oil imports for petroleum products. India’s export growth was negative for fiscal year 2014-15 and trade deficit rose by less than 1% largely due to fall in oil imports.
The fiscal deficit situation was worse when the new Government came into power and now has been contained at 4.1% of the GDP at the end of FY 2014-15. Fiscal deficit was at 4.5% of GDP in fiscal year 2013-14. Government plan expenditure was down 14% for last fiscal year from budgeted levels and that helped control fiscal deficit. Cutting plan expenditure leads to lack of creation of infrastructure that is required to improve supply side economics and keep down inflation expectations.
The GDP growth was revised to a new base year of 2011-12 from the earlier 2004-05. According to the changed base the GDP grew at 7.4% in the fiscal 2014-15 and is expected to grow at a rate higher than the last year in fiscal 2015-16. However, the revised GDP numbers (GDP growth for old base year was 5% to 5.5%) does not indicate any robustness in the economy. IIP (Index of Industrial Production) growth for last fiscal year was at 2.8% levels up from negative 0.1% levels seen for fiscal 2013-14. Manufacturing growth was 2.3% from negative 0.8%. Industrial production is still weak and needs to revive for economic growth.
The credit growth was reported at below 10% for the last fiscal year as compared to last year growth of over 14%. Banks are risk averse given that Gross and Net NPA’s are at levels of 4.45% and 2.36% respectively and total NPA’s including restructured assets is at 10.9%. Government has to enable banks to recover from bad loans and stop directing their lending activities.
The Goods and Services Tax (GST) is on track to be implemented by the new Government in the next Financial Year (2016-17) and would simplify things for the economy as a whole. The market would take cues from the same in the beginning of the calendar year 2016. Simplification in the taxation for corporates would definitely make way for rise in efficiency pertaining to tax matters.
The ten year Government Bond yield was trading at levels of 8.8% in May 2014 and currently trades at 7.94% in May 2015.
The Bond market has definitely factored in the improvement in the economic conditions in the last one year but for bond yields to sustain at lower levels, the government has to deliver on fiscal reforms. Bond yields have trended up from lows on the back of global bond volatility.
Sensex was trading at a P/E of 19x its FY14 earnings in the month of May 2014 and currently the index trades at a P/E of 19.33x its FY15 earnings in the month of May 2015. The valuations have not become extremely expensive but expectations had pushed Sensex levels to 30,000 in the month of March 2015 that had a P/E of 22x its FY15 earnings. The excess valuations have been trimmed down in the recent correction and high expectations are keeping the interest for long term.
The sectors that were riding on Modi hopes were Banking, Infrastructure and Oil and Gas. Banking had issues of bad loans especially the Public Sector Banks and that is the reason they were trading cheap at below 1x price to book value while private sector banks were trading at well over 2x price to book value with some of them like HDFC Bank and Kotak Mahindra Bank at around 4x price to book value FY15 earnings. The Public sector banks still continue to witness high and rising levels of NPA in the current scenario. Punjab National Bank’s net profit declined 62% to Rs.3065.6 million on the back of rising NPA’s with a 7.6% growth in total income to Rs.134556.5 million in Q4FY15 over Q4FY14. Even though the Government will take some time to bring things in order for Banks in particular a favourable credit growth scenario looks possible only if interest rates are fundamentally brought down to affordable levels.
Infrastructure companies faced slow to negative growth because of high debt levels in the sector, along with lack of money for spending followed by lack of clearances by various ministries in last year same time. The scenario has definitely changed with respect to clearances the new government has given for pending projects along with new sanctions and robust plans for future. The interest rates have marginally declined and inflation has come within the target limits of the RBI which would further initiate more interest in new projects for Infrastructure funding as well.
Oil and Gas sector companies suffered because of Government control before the newly elected Government at the centre. The diesel fuel was deregulated when oil prices crashed to multiyear lows due to the US Oil glut. Deregulation in the diesel prices was a decision taken by the Modi led Government a decision which was not taken by the Congress led UPA Government due to political reasons.
Overall, the policy initiatives and implementation has been a mixed bag for the newly elected Government. It would take a while for the growth to percolate to industry and further to company level. Sensex and Nifty have factored in most of the growth that this Government can deliver in the near future. The industry requires some favourable policies for sectoral growth to revive but the Government at the moment is caught up with management of issues at the Central and State level. Looks like the market would struggle to catch with the record levels of 30000 that was breached in the month of March 2015.