A rally without spine?

The Nifty is trading at a P/E over 23 - well above the discount for 15% EPS growth

The Reserve Bank of India (RBI) uses multiple surveys to assess consumer and expert expectations. It doesn’t publish too much detail about the way these surveys are constructed. So, we must take the rigour on trust. One set of surveys involves professional forecasters. Another involves consumer and household expectations. The professional forecasters are asked questions about macroeconomic trends. The questions to consumers range around inflation expectations, employment, spending plans, etc. 

Such surveys could have large error factors — at several levels. Survey construction could also lead to biases. Forecasters are also often wrong in their projections, as are households. However, assuming the surveys are well-constructed and rigorous, the results are important.  

Professional forecasters’ projections influence institutional investment flows and corporate strategies. Also, central banks take household inflation expectations seriously, as these can be self-fulfiling. Household expectations influence buying, savings and investment decisions. In India, household savings form, by far, the largest component of national savings. Consumption also makes the largest contribution to gross domestic product (GDP). 

The March 2017 survey targeted 21 professional forecasters who are mildly optimistic about this financial year, albeit less so than in the earlier round of the same survey in December 2016. 

In detail, these forecasters expect gross value added (GVA) growth to rise to 7.3 per cent in 2017-18 (up from 6.7 per cent in 2016-17). They believe services and industry will see acceleration but agriculture will get slower. Gross savings rates and private final consumption expenditure will improve a little. Merchandise export and import will grow after three years of near-stagnation. 

The inflation indices will move in opposite directions. Consumer Price Index (CPI)-based inflation (estimated at 3.6 per cent in the fourth quarter of FY17) will rise to 5.3 per cent in Q4 of FY18. Core CPI (excluding food and fuel) amounts to less than half of the CPI weight. But, core will run at a “sticky” 4.9 per cent. Wholesale Price Index-based inflation will ease from the current 6.55 per cent to 3.7 per cent by Q4, 2017-18. 

Both the central and combined fiscal deficits are expected to reduce slightly, with the central fiscal deficit down to 3.2 per cent from 3.5 per cent for 2016-17 of the GDP. Bank credit is expected to rise 10 per cent, better than the multi-year-low of six per cent in 2016-17. Yields on the 91-day treasury bill and the 10-year government bond are expected to be at 6.3 per cent and 6.7 per cent, respectively, by March nest year. This gives a fix on interest rate expectations. It is just 20-30 basis points lower than in 2016-17. The implication: Little change in policy rates. 

The consumer surveys polled 5,084 urban households. A large proportion of the respondents (81 per cent) expect higher inflation in the next three months, compared to the previous round (68 per cent expected price increase in December 2016). About 45 per cent of respondents expect inflation rates to accelerate. 

Current expectations about the general economy are negative, for the first time since September 2014. Future expectations have worsened but remain positive overall. There are marginally improved expectations in terms of income, employment and spending. 

Both professional forecasters and households could be wrong in consensus assessments and RBI’s own assessment might differ markedly from those revealed by the survey. In fact, going by previous surveys, households seem to consistently overestimate inflation in the consensus. Professional forecasters’ median forecasts are often “conservative” and underestimate changes in macro-trends in both directions. Right or wrong, these surveys offer nuanced and slightly negative projections on many counts. At first glance, there is nothing to justify the huge rally over the past three months. Looking closer, the expected acceleration across industry and services could be reflected in higher growth rates for corporates. An old rule of thumb suggests corporate earnings can grow at twice GVA — that's about 15 per cent — during a favourable cycle. The National Stock Exchange’s Nifty 50 is now trading at a price-to earnings ratio of over 23, well above the reasonable discount for 15 per cent earnings per share growth.