The great Indian reset

The Nifty's fall has adjusted expectations downward to more realistic levels

In all likelihood, the Nifty will end 2015 at the same levels as a year ago. One year of zero returns is tough but then expectations now appear more realistic. Optimism from a new Government and the heady days of global liquidity on tap are now over. The world looks grim with China adjusting to lower growth and the U.S. gearing up for an economic recovery.
Between these two giants, India is loose change. India’s economic turnaround is now well known and fully reflected in the Nifty’s outperformance of Emerging Market (EM) equity indices and the resultant premium that the Nifty commands over its EM peers. That is the past and that story has now run its course. Investors are increasingly focusing on real recovery, at the macro-economic level and the translation at the micro corporate level. 

At the macro-economic level, all bullish projections of GDP growth have been toned down. 1QFY16 GDP growth printed at 7% and a significant jump from these levels is highly unlikely for the rest of the year. The rebound in industrial growth (3.6% in 3QFY15 to 6.5% in 1QFY16) has been offset by the decline in services growth (12.5% to 8.9% over the same period).  The RBI expects GDP growth at 7.6% in FY16 but this forecast currently appears optimistic. While industrial growth is showing a rebound, large sectors like power and steel are stuck with over-leveraged balance sheets. Falling commodity prices have driven CPI inflation lower, but consumption-based growth has also slowed down. Savings, if any, at the consumer level due to lower inflation have not yet translated to higher demand.  Thus, on the economic front, expectations are now more realistic that growth will hover around the 7% mark for FY16 and, in all probability, FY17. 

The RBI has cut policy rates by 75bps across three occasions this year (Jan, March and June). Given the recent fall in CPI inflation, consensus expectations are for another 25bps rate cut on or before the next policy meeting on 29th Sept. A sum total of 100bps cut in policy rates in 2015 is broadly in line with the fall in CPI inflation and is unlikely to be repeated next year. Another 25-50bps cut in 1H2016 appears more likely, depending on the trajectory of inflation. Any further expectations from the RBI appear unrealistic. 

More importantly, the expectations around the NDA Government appear more realistic now as compared to the hype after the huge 2014 victory. Hope for overnight big-bang reform (GST, Land Acquisition Bill) has now moderated to accepting incremental steps (labor reform, steps to boost PSU Banks, etc.). Moreover, reforms pertaining to labor, land and power have also moved to the level of states for implementation. Deeper, structural reforms – such as the Black Money Bill, transparent pricing for auction of natural resources, financial inclusion etc. will all take a long time to work their way through the system. 

However, a bigger expectation from the Government is to improve the quality of spending – i.e. moving from subsidies to capital expenditure. Upgrading India’s rail and road network has the potential for improving infrastructure and creating jobs. Nothing in this idea is new and has been seen in the past (Golden Quadrilateral, turnaround of Railways, etc). The Government can easily deliver on this front in the coming years without much strain on its balance sheet. 

What does all of this translate to for the stock markets? Three things. A) Global events will continue to dictate the moves of the Nifty. B) India’s premium to other Emerging Markets makes it vulnerable to any global sell-off and C) India’s government, more than the RBI, holds the key to longer-term performance of Indian equities. 

The rose-tinted glasses have come off. The reality looks grim but the future looks full of opportunity.

Anupam Gupta is a Chartered Accountant and has worked in Institutional Equity Research since 2000, first as an analyst and now as a consultant.

He contributes to the Business Standard platform, Punditry through his blog, Beyond Markets on markets & the economic horizons. He tweets as @b50