Devangshu Datta: Political risk tempered by bullishness

Assembly poll results will indicate if BJP will weaken or become stronger

Investors sometimes downgrade economies on the basis of “political risk”. That is generally associated with Third World dictatorships, where coups or civil wars can lead to chaos. Political risk is now being alluded to by investors fleeing the US bond market. Some institutions are also considering pruning exposures to France and Holland. Political risk is also a factor in India with its string of assembly elections.

While the US stock market has rallied to new highs, the bond market has looked distinctly nervous, with overseas investors pulling out as the Trump Administration stumbles around.  There is a chance that anti-European-Union (EU) right-wing elements could win political power in Holland. In France, the extreme right wing candidate, Marine Le Pen, is also making a strong bid for presidency. If the right does get into power in Holland or France, there could be attempts made to lower the boom on immigration and refugees, and perhaps, exit the EU.

The Assembly elections will be parsed for actual results as well as for details of vote share. Uttar Pradesh is seen as the key arena. But the Bharatiya Janata Party would be weakened if it lost vote share and seats in Goa, Uttarakhand and Punjab.  
The results from the “demonetisation quarter” (Q3, 2016-17) delivered a welcome surprise. The global commodity cycle has seen an upswing. Sugar was on a bull run. The Q3, 2015-16 was also weak, which created a base effect. The results of 1,660 listed companies show that net profits grew year-on-year at 27.7 per cent, which was really quick. Revenues (including other income) rose nine per cent, the best in two years.  

A big contribution came from metals. Energy also remained in a sweet spot, with both producers and refiners delivering high profits. Banks delivered high profits, based on treasury gains and lower provisioning.

IT, pharmaceuticals and FMCG all had anaemic performances. Information technology and pharma were hit by fears of US policy action. FMCG suffered as consumption dropped. Construction and real estate saw losses while power generation companies saw a downturn. Automobiles and auto-ancillaries had spotty results. Maruti gained, Tata Motors took a hammering in JLR. Bajaj Auto and Hero Motors lost ground and tractor-makers Escorts and Eicher gained.

The results certainly indicate reassuring resilience. However, there are also visible negative impacts from demonetisation. The balance sheets of public sector banks remain a mess, with talk of a bad bank. The State Bank of India merger will create a larger entity but it has terrible financials with gross non-performing assets (NPA) rising to 8.5 per cent of total advances (or higher). Most public sector banks (PSB) reduced provisioning for NPAs and reported higher profits on the basis of treasury gains. Many PSBs are technically bankrupt or close to it, with net (unprovisioned) NPAs more or less wiping out net worth. Incidentally, the data indicates that the deposits from demonetisation were all parked in treasuries, with bank credit to industry growing at a minuscule five per cent.

Treasury yields have since moved up, as the Reserve Bank of India refused to cut rates at its last policy review. The Consumer Price Index (CPI) was low in January at 3.17 per cent year-on-year due to a sharp decline in food inflation to 1.29 per cent. Food is about 47 per cent of the CPI basket.

But the Wholesale Price Index (WPI) is up to 5.25 for January and that is a 30-month high. Core inflation (the CPI basket stripped of food and fuel components) is at 4.98 per cent. Fuel inflation jumped, with high-speed diesel, LPG and petrol up by 31 per cent, 1.5 per cent and 15.7 per cent respectively in January 2017 year-on-year. Fuel has 15 per cent weight in the WPI basket.  

The last time WPI printed higher than CPI was in the period January 2011-January 2012 when crude was again the culprit. The Index of Industrial Production was down in December at minus 0.4 per cent. The January Purchasing Managers’ Index (PMI) indicated a modest growth recovery in industry with the manufacturing PMI at 50.4. But the services PMI of 48.7 indicated contraction for the third month running. (A PMI of above 50/below 50 indicates expansion/contraction respectively.)

On the corporate front, the ongoing battle for hearts and minds in Infosys could be a symptom of the software industry hitting a rough patch. HDFC Bank saw a huge spike when clearance for a larger foreign portfolio investment (FPI) holding came through. But the 74 per cent limit was immediately breached, creating a mess that will have to be sorted out.

The USD has now started weakening, perhaps due to outflows from the US treasury markets. Gold is up eight per cent this year versus the USD, and the bitcoin has moved up 12 per cent versus the USD. The GBP is down on Brexit fears and pound weakness is translating into inflation for the UK.

America’s loss could be India’s gain as FPIs have invested quite substantially in rupee assets during February,  even as they’ve cut USD exposures. The technical picture continues to look bullish, with steady gains since last December. The Nifty and the Bank Nifty continue to register a pattern of higher highs.