After sharp run-up, earnings will decide if the party continues: Patnaik

Interview with Tirthankar Patnaik, India strategist, Mizuho Bank

The focus on market-friendly reforms, especially in investment, infrastructure and Goods and Services Tax (GST), will continue to remain a priority for the government, says TIRTHANKAR PATNAIK, India strategist, Mizuho Bank. In an interview with Puneet Wadhwa, he says the Bharatiya Janata Party’s massive victory in Uttar Pradesh will also help it take tougher decisions on second-generation reforms like in labour laws, police and land. Edited excerpts:

How do you interpret the outcomes of the recently concluded Assembly polls? What more would you like to see from the government in terms of policy action? 

While a Bharatiya Janata Party (BJP) victory in Uttar Pradesh (UP) was a consensus call, the margin of the final tally, significantly beyond what was projected by most opinion and exit polls, was a strong positive surprise. The BJP’s performance continued in other states as well, apart from strong anti-incumbency in Punjab, and cemented Narendra Modi’s position as the leader of the government. The results showed that a dominant mandate, accompanied by a judicious mix of performance and risk-taking, and a sustained focus on elections, tends to be rewarded, even in the wake of disruptive policies like demonetisation, with questionable long-term benefits at best. 

We do not foresee any major change in the government’s focus on reforms, especially in investment, infrastructure, GST, etc, simply because such areas have remained top-priority for a while. The markets, therefore, consider the poll victory as a precursor to the 2019 general elections, adding to the Lok Sabha tally (read political stability) of 2014, which in itself was the highest since 1984. Such a possibility of successive terms allows the incumbent to take tougher decisions on second-generation reforms like in labour laws, police, and land, many of which are either in concurrent lists or with the states. We also believe the mandate is likely to blunt efforts by opposition parties to stymie ongoing initiatives like the GST. 

Can the market sustain these high levels for the next 12 months? Where do you see the Nifty by December? 

Valuations-wise, the market is at 17x FY18 PE and 14x FY19 PE. A number of factors have worked in favour of this year: Inflation has remained low, and even the Reserve Bank of India’s (RBI’s) change in stance focused on expectations of a revival in growth which received a boost with the third quarter GDP print of seven per cent, despite demonetisation; bank NPAs (non-performing assets) are showing signs of stability, as are commodity prices. The massive win in UP adds a significant amount of incremental political stability as well, and has been the key support behind the market’s move to life-time highs of 9,100 levels. Given the market’s sharp run-up this year, it would now depend on earnings performance (upgrades/ revisions) for the party to continue, beyond the benign macro fundamentals and favourable positioning among EM (emerging market) peers. There are many factors that could play spoilsport. 

Are the markets fully factoring in the GST impact and the delay in pick-up in corporate earnings due to note ban? 

Earnings growth this financial year is expected to be around 11 per cent, after downgrades during the demonetisation phase, of four per cent for FY17 and six per cent for FY18. On a low base, FY18 earnings are likely to grow 20 per cent, before tapering to a sedate 15-16 per cent in FY19. Third quarter earnings have been remarkably resilient, at least at the index level, driven by sectors like commodities and financials. We believe, however, the overhang of demonetisation would remain on fourth quarter earnings, and current consensus earnings might see further downgrades. To some extent, that would push up estimates for FY18. We believe the implementation of GST is on track for July, but full implementation and assimilation by companies might take much longer, and we would not rule out disruption in earnings, as supply chains gear up to the new tax regime.

What are the key risks for Indian markets? 

The March quarter might see additional impact of demonetisation and NPAs could rise again, there are risks on the monsoon, and a sharper-than-expected rise in global interest rates might hurt capital flows in a meaningful way. Domestic yields have practically bottomed out, after the change in stance by the Reserve Bank of India, and look set to inch up, partially in line with global rates.