Slowdown across sectors

The macroeconomy is in trouble, GDP numbers are miserable and note ban has yielded poor results

The stock market continues to ignore signs that India Inc and the macroeconomy are in trouble. Gross domestic product (GDP) estimates for Q1, 2017-18, are miserable. The Reserve Bank of India annual report confirms, if any confirmation was required, that demonetisation had poor outcomes. The Q1 corporate results are also poor. There are far more downgrades than upgrades and there isn’t a single sector growing at a pace that justifies respective valuations.

Despite all that, money continues to flow into stocks. While domestic institutions bought over Rs 16,000 crore in August that was almost balanced by the Rs 14,000 crore plus that foreign portfolio investors sold. Retail also continues to push in money and, importantly, that has boosted smaller stocks. The Nifty is up 21 per cent in calendar year 2017.

The GDP growth rate in April-June 2017 dipped to 5.6 per cent year-on-year, the slowest growth since January-March 2013. It’s 2.2 per cent lower than April-June 2016. Nominal growth (including inflation) is the lowest in several years at nearly 10 per cent. Government expenditure expanded. Private consumption contributed 4.2 per cent to growth. A lot of the activity appeared to be jewellery-related, which is not reassuring.  

Manufacturing was stagnant at 1.2 per cent year-on-year while agriculture grew two per cent. Imports expanded 13.4 per cent, exports grew 1.2 per cent.  The investment cycle remains muted, with growth at just 1.6 per cent. Government expenditure led to the fiscal deficit hitting 93 per cent of the 2017-18 Budget annual estimate in the first quarter. It’s unlikely that it can be sustained at these levels. 

Interestingly, nominal growth in agriculture was lower than inflation-adjusted real growth. Deflation wiped out food prices and this explains massive farmer agitations and low rural consumption. Incidentally, food prices have now started rising due to supply shortages. This is in line with previous experience with the erstwhile Soviet Union’s demonetisation in 1991. Farmers didn’t have the money to plant at the right time and that means lower harvests. Widespread floods in the east will not help matters.

  

Another explanation offered for the slowdown, apart from demonetisation’s evil legacy, is “destocking” ahead of GST. This is plausible until you notice that inventories shot up by 66 per cent, which is at odds with destocking.

The RBI had transferred a dividend of Rs 30,650 crore as surplus to the government. That was Rs 34,500 crore less than in 2016-17 — one cost of demonetisation. The delayed annual report of the central bank indicates that over 99 per cent of the banned notes are back in the bank (and there could be more coming back from Nepal). Fake notes were less than 0.001 per cent. 

That’s a maximum seigniorage write-off of Rs 16,000 crore versus a direct cost of Rs 8,000 crore spent on the demonetisation by the RBI. This is a far cry from the Rs 1.5 trillion of unreturned notes that some eminent economists were confidently expecting. More than 100 deaths in queues and an estimated five million job losses across the informal sector, with the knock-on effect of collapsing consumption seems to be rather a large price to pay. 

Some “optimists” took heart from the slowdown, asserting that the RBI will now be forced to cut rates again. The GST seems to have got off to a good start and the market certainly took comfort from excellent initial tax collections. However, we’ll have to wait for net numbers after offsets before we can figure out how GST is actually working. Also, industry and services are going through working capital crunches since the tax offset cycle, as predicted, is much too slow.  

The Nifty 50 saw 29 earnings downgrades and the Nifty 100 saw 62 downgrades. Overall profit growth was flat across the largest businesses. According to Bloomberg, consensus EPS estimates across the entire stock market have been downgraded by about eight per cent. Low double-digit earnings growth is the consensus expectation for the rest of the fiscal. Given valuations running at PE 26-plus, the word “bubble” comes to mind. The manufacturing Purchasing Managers’ Index for August does indicate that the industrial sector has started expanding after contraction in July. So, there’s some hope. 

The confusion continues in Infosys, with another round of insults exchanged. There are rumours that some founders might cash out or reduce their personal exposures by offering stakes in the buyback. This could lead to another crash, post buyback.

Geopolitics did not impinge much on the Indian market last fortnight. There was relief as the Doklam stand-off ended. There are optimistic noises about US tax reforms, though there are doubts about the Trump administration’s ability to push those through. The US economy was strong in April-June 2017, with GDP growth at three per cent.  The UK continues to negotiate “divorce” from the European Union, where there is also economic expansion. 

Technically speaking, the market has recovered from a correction down to 9,700 Nifty. It is consolidating within a narrow range of 9,800-10,000. Typically, such phases of range trading end in either a sharp breakout, or a sharp breakdown, caused by some news trigger.