Devangshu Datta: Heading into the new year with a hangover

It's quite obvious that the remonetisation exercise will be nowhere near complete by December 30

December is traditionally a low-volume month. Foreign portfolio investors (FPI) have financial year-ending coming up and everyone goes on holiday. This year, the smart money will also stay on the fence until there are news triggers and data points available. One theme is already visible. FPIs are moving to USD-denominated instruments and out of emerging markets.
 
Central bank policy clarity is also emerging. The Federal Reserve has hiked USD policy rates. The European Central Bank has extended its bond-buying timeline and cut the monthly quantum. The Reserve Bank of India (RBI), the Bank of Japan and the Bank of England have all maintained status quo. Japan and Britain have raised gross domestic product (GDP) growth estimates, while the RBI has lowered them. Italy is on the edge of a bank crisis.

China suffered its slowest GDP growth since 1991. The bond market has seen yields zooming. Inflation is up. The yuan is at eight-year lows. Reserves have dropped by over $1.2 trillion. Will the People’s Bank of China cut rates to stimulate growth, or will it hike to reduce speculation and capital flight? 
 
Another question is the attitude of the US administration. It’s hard to tell what Donald Trump and Co intend to do. The Fed is braced for higher inflation but that doesn’t mean it will happen. A strong dollar would normally stimulate imports but not if there’s a protectionist stance.
 
It’s quite obvious that the “remonetisation” exercise will be nowhere near complete within “the 50 days” ending December 30. It’s also obvious that most, if not all, denotified currency will come back. So the RBI cannot cancel liabilities.
 
Hence, currency withdrawal controls will remain, retarding consumption. The Q3 corporate numbers will start coming in January. So will macro data like industrial production data for November, inflation data and purchasing managers’ indices (PMI) for December. This will offer a hint of the quantum of damage.
 
While there’s likely to be lower revenues and reduced profits (or higher losses) across the board, bank balance sheets could undergo special stresses. Non-performing assets (NPA) are likely to rise. The credit-deposit ratio has fallen to multi-year lows, as has credit growth. By September 2016, public sector banks held Rs 6.3 trillion worth of gross NPAs. That figure will have risen some more.
 
Banks must figure out how to pay interest on the swollen deposit base, given few borrowers for that money. Public sector banks, or rather their owner, the government of India, must also figure out how to recapitalise. This may provoke a crisis, forcing reforms in the banking sector.
 
On the macro front, everybody is braced for negative indices of industrial production, lower inflation and a haircut in GDP growth. But estimates vary wildly. So do projected timelines for recovery. Nor does anybody know how many people have been laid off, and if those lay-offs are temporary. December PMIs and high-speed data such as dealer order for vehicles, mortgages, cement despatches will be useful as gauges of sentiment, as will earnings of course. On the sentiment side, it will also be interesting to see what the Tata-Mistry-Wadia spat does to market capitalisation for India’s largest business group.
 
We have a sampling of advance tax estimates from December. The 43 largest firms in Mumbai have, in total, submitted 10% more in advance tax in Q3.  Biggies with lower payments include SBI, Bajaj Auto, ICICI, TCS, Tata Steel, Hindustan Unilever, UltraTech, etc.
 
Where the Union Budget is concerned, the surge in deposits will make it easier for banks to subscribe to Treasury Bills at low yields, reducing the cost of financing the Fisc. But there is no clear way to offset, and compare likely tax revenue gains directly from demonetisation, versus tax revenue losses from lower productivity and lower consumption.
 
There are several persistent rumours floating around about the Union Budget. One is that it will slash income tax rates or raise the exemption limits a lot. Maybe that is credible. But it would depend on whether the government could afford to forego tax revenues.
 
Another big question mark is the GST. Will the GST be implemented in April? It now looks unlikely, given hardening opposition across several of the 29 states. Low activity has meant falling state revenues and many states are reluctant to switch to a new system now. Also, there is negotiation left to be done about which service (state excise departments or central excise) controls assessment of what industry. Companies are nervous, since this uncertainty retards tax planning and business strategy. 
 
The results of the Assembly elections coming up could influence GST timelines by either strengthening or weakening the Bharatiya Janata Party’s hand. If there’s a GST logjam, the current indirect tax system would lapse by mid-September 2017. That could be sorted out with a Money Bill given a Lok Sabha majority.
 
 FPIs sold over Rs 60,000 crore (Rs 40,000 crore in debt) in November and December. The rupee stays under pressure. The Nifty and Sensex are now trading far below the respective 200-Day Moving Averages, indicating the likelihood of persistent bearishness going into the new year. If the Nifty falls below 7,900, it could slide till 7,500 in short order.