The end of a secular bull run is always difficult to call. Fireworks went off in early 2014, anticipating a BJP victory and the euphoria sustained till June 2019.
Let’s see whether the triggers of this wealth creation still exist:
- Oil prices crashed to an average of $45 giving the Government considerable headspace for fiscal consolidation;
- The drop in inflation led to a decline in consumer lending rates creating a consumption boom;
- Aggressive infrastructure creation spending by the Government in rural India fueled demand to new heights;
- The RBI cracked the whip on NPA recognition by banks, and the Government stepping in to recapitalize the sector enhanced investor confidence;
- ‘Demonetisation’was a poorly thought out economic action, but the short term injection of $150 billion into the banking system prevented a run on PSU Banks;
- As PSU banks addressed their survival issues, the opportunity for growth was left wide open to private banks and their valuations catapulted making PSU banks’ valuation irrelevant in indices;
- De-bottlenecking of many sectors and resolution of delayed projects with speedy execution especially in Roads was a boost;
- TheGovernment continued to milk the oil sector for meeting its revenue and cashflow needs. Consumers ignored the loss of benefits to them from lower crude prices as the general mood was buoyant;
- Funds flowed into Mutual Funds and Portfolio Management Services as an equity culture started to build;
- GST broke the back of the real economy consolidating market share in the hands of the large organized sector. Global investors cheered, but the SME sector got butchered and job losses became rampant;
- The Government enjoyed very high credibility as no scams were unearthed; and
- Productivityin agriculture grew, but benign market prices prevented real benefits and agrarian distress continued to spiral.
Hence, when one looked at the performance of the following big-ticket items, we seemed to be in a good space:
- Fiscal Deficit: maintained its declining path;
- Balance of Payments: improved with small export growth, lower gold imports, lower defence imports, and strong NRI remittances along with IT/ITES net exports;
- Inflation: a commodity cool-off led to wholesale inflation dropping, and lower fuel and farm prices kept consumer inflation down;
- Growth: Industry grew in a jobless manner, Agriculture was muted, Real Estate faced a meltdown, Construction was fueled by Government spending, Retail Banking grew, as did Insurance. Transportation maintained its upward trajectory driven by the consumption mood; and
- Employment: remained very challenged in the organized sector as the impact of technology on productivity was seen.Very few new projects were visible in the private sector, but the Government responded with lending nearly $60 billion under the Mudra scheme to first time entrepreneurs.
This was an unprecedented period of wealth creation, which came with its associated challenges. Price Earning ratios started hitting 26 for the index and the Indian markets were out of whack with the rest of the world. Fund managers came up with absurd justifications to explain valuations of many companies. The froth was building up, but it was sustained by a very liquid global economy and very high domestic consumer confidence. Markets corrected nearly 15% in the 3 months prior to the 2019 elections, but ran up to a new high in 2 months once it was clear that the Modi Government was being re-elected.
Markets had continued to run-up ignoring the warning signs in the last 18 months. The expectations of a miracle from Prime Minister Modi were sky high.
Here’s what changed in July 2019:
- The Finance Minister,Nirmala Sitharaman, made a strategic error in choosing an investment led model over a consumption stimulus based model, selecting the long term over the short term;
- She signaled to the honest taxpayers that they need to pay more, but did not show any action to cut bloated Government spending;
- She rocked the boat of the Foreign Institutional Investors by changing taxation of Foreign Portfolio Investors, at an unfortunate time, given that they had kept the market valuations up;
- Investors suddenly remembered that:(a) President Donald Trump had made world trade unpredictable, with conflicts with the Chinese and with Iran, which impacts 20% of India’s crude imports; (b) crude prices had climbed back to $70; and (c) the Government’s safety net had dwindled;
- Prime Minister Modi discovered that being a better welfare politician (perhaps even beyond the imagination of the Communists!) won electionsand consequently, increased freebies to farmers, and strained the budget even more;
- The Automobiles sector, reeling from a collapse in consumer lending due to the crisis in the NBFC space, lower rural incomes, and now an urban consumer buying slowdown, reported a drop in revenues nine months in a row. Two wheeler sales have dropped for the first time in 15 years;
- Tax collections for the first quarter show thatGST is up 1% and Corporate taxes are up 6%, whereas the Finance Minister assumed an 18% growth in the budget. Net result: a mismatch is looming large. To compound this, the IT department chose to tighten the screws on high tax payers on top of a 7% to 10% hike in tax-rate for them in the budget; and
- Aseries of corporate frauds, negligence, suspected connivance by auditors, rating agencies, regulators and bankers totally rattled markets.
The index continues to be a good statistician – it hides more than it shows. We have seen a 10% correction in indices in July 2019, but the carnage in the small and mid-cap segments is so huge that it has left investors battered. It’s not that the goose wasn’t being cooked from mid 2016, but the bubbles have their own life, and reality was waiting to bite.
Let’s look at the Macro indicators with a sense of reality. Economic indicators generate confidence when no questions on integrity of data exist. The attack on the Government by its former RBI Governor, and then by the Chief Economic Advisor dented its image.
Notwithstanding that, the assumptions in the budget must clear scrutiny:
- In a slowing global economy, with the domestic corporate sector showing a sharp drop in profits in the first quarter-what’s the Government’s Plan B for meeting revenue targets?
- Private sector capital investment has completely slowed, and no amount of pep talks by the Niti Aayog is going to change this. It needs real engagement with a friendly and not an adversarial attitude. The Government’s projected GDP growth numbers with a benign inflation look like a real stretch;
- Government spending continues to grow with another Finance Commission on the way;
- BOP numbers may become more challenging with de-growth in exports, given the world trade situation. Our imports tend be inelastic. It will need political courage to tackle new import growth areas like Food, Consumer Electronics etc., which are non-domestic non value-add consumer spending.
- With the Government committed to raising farm incomes sharply, consumer inflation threatens with every Minimum Support Price hike that is announced.
The investor mood today is despondent. The faith in the regulators and administrators gets reduced with every new corporate scam that gets disclosed. The present regime may have nothing to do with the genesis and perpetuation of the problem, but they bear the onerous responsibility of cleaning up and putting the house in order.
Markets are one place where you have to put your money where your mouth is. Platitudes do not work. Actions speak louder than words. Investors move well ahead of the curve, they understand risk, and may switch to a total risk-off mode.
The current conundrum is building up into a storm whose momentum may take its own direction and hurt us economically as a country, something perhaps not envisaged today by the policy makers. In my perception, we have a 10 week window to start course correction, or we may be setback by 2 to 3 years.
In my subsequent blog posts, I will write about the specific sectoral issues crying for attention. I would love your feedback, which I promise to consolidate and present.
Sanjit Paul Singh
Managing Partner S&S Associates