Devangshu Datta: Optimistic but bracing for impact

With the Budget round the corner there are expectations of sops

Investors will suffer information overload in the next few weeks, as data are released and policies reviewed. Globally, inflation is rising, crude is up and the dollar is stronger. The European Union is hoping for a big earnings rebound after years of stagnation; the US is also hoping for earnings acceleration. A protectionist American administration is flexing its muscles even before taking charge. China is burning forex reserves to shore up the falling yuan, but Chinese growth is also picking up.

On the domestic front, the announcement of sundry Assembly elections and the advancement of the Union Budget has pushed investors off-balance. The “50 days” of notebandi have ended but the pain hasn’t. There’s not enough data out yet to compute how bad Q3 was. But official gross domestic product (GDP) estimates have been cut substantially, even without demonetisation factored into models.

The markets usually tend to be optimistic in the pre-Budget period, with traders betting on sops. This time, too, there are rumours of several sops and indeed, it’s rational to expect handouts. The prime minister’s December 31 speech more or less guaranteed handouts aplenty. Banks have made substantial rate cuts as well. 

Although the market has responded positively, everyone is bracing for a terrible earnings season. Poor Q3 earnings will be discounted and so, looking ahead, will poor Q4 earnings.  Earnings trends would, however, help quantify and pinpoint areas of distress. Banking could be among the most critically affected sectors. Non-performing assets are bound to have risen and fee-based income will also have fallen, as bankers were busy counting notes.

The market is also braced for the negative impact of a possible delay in rolling out the goods and services tax. The timeline depends to a large extent on state government attitudes and those have hardened. Assembly election results, especially in Uttar Pradesh, could also have some bearing. 

The pace of recovery from demonetisation depends on the return of consumer confidence, the speed and extent of remonetisation, the repair of damaged supply chains and price stability in food and fuel baskets. The cash withdrawal limits per week have not been changed. There have also been so many breaches of commitment that it is hard to make any predictions about the road map ahead.

As of now, about 97 per cent of currency has returned. The State Bank of India chairperson estimates that around 40 per cent of the enforced deposits will stay in the banking system. There could be troubling asset-liability mismatches if long-term mortgages at low interest rates are offered on the basis of swollen savings account deposits.

The Central Statistical Organisation has projected, on the basis of April-October data, that GDP growth for FY 2016-17 will be 7.1 per cent. That is a significant 0.5 per cent reduction from earlier estimates of 7.6 per cent. Despite this, Finance Minister Arun Jaitley claims tax revenues will be buoyant and exceed Budget estimates. The 7.1 per cent figure is also surely an overestimate. Since November, private consumption has collapsed, exports are running negative for 2016-17, and government expenditure will be sliced since the fiscal deficit had hit 86 per cent of estimates by November itself.

High-speed data in November-December is showing some negative impact. Two-wheeler and three-wheeler dealer despatches dropped 21 per cent year-on-year in December 2016, while passenger and commercial vehicle dealer despatches saw 0.5 per cent rise year-on-year. New vehicle registrations are said to be down by a third in several states, so inventory build-ups may be brewing.

The Purchasing Managers’ Indices for November (service and manufacturing) and December (manufacturing) suggest contraction of an order not seen since late 2008. A sharp drop in consumer inflation supports contentions that demand has crashed and that’s also borne out by bank credit at multi-year lows.

Core sector data for November shows growth slowdown, though that eight-sector set was in positive territory. The overall Index of Industrial Production data (core contributes 38 per cent of IIP) is due next week. November 2015 was low base (Diwali fell in November 2015) versus November 2016 (no festivals) but IIP is expected to run negative. 

The Budget will be announced and computed before the demonetisation shock is quantified fully. IIP for December will not be out, for example. Hence, Budget estimates for 2017-18 and revised estimates for 2016-17 may have huge errors.

Meanwhile, crude is trending up, which is a source of worry. The Trump administration has not yet taken charge but the president-elect is bullying US carmakers and air conditioner firms to bring jobs back to America. The proposed Protect and Grow American Jobs Act, which was introduced in the US Congress, includes changes to H1B visa norms, which could impede Indian IT firms.

The market has swung quite a bit, on low volumes. The Nifty dropped to 7,890, (December 26) and it’s tested 8,300 last week in a recovery that was driven by domestic institutions. It’s hovering near the 200-Day Moving Average now, which means that it’s hard to classify as either bullish or bearish.

Foreign portfolio investors (FPI) have been net sellers for months. Indeed, all emerging markets experienced low FPI inflows in 2016 — the lowest since 2008. The trend through February and into 2017-18 will depend on FPI attitude. Apart from their assessment of the Budget, etc, India starts levying capital gains taxes on FPIs operating out of Singapore, Mauritius and Cyprus. That could be a disincentive.