2015 was a historic year! Almost all asset classes across the world will close in red.
It started with the Euro depreciation due to its continuation of QE by ECB. It was followed by Swiss Franc un-pegging itself from Euro after being pegged for four years. The Chinese Yuan devalued its currency for the first time in 21 years creating a flutter across Asian currencies. Malaysian Ringgit touched the 1997 Asian crisis levels. All commodities – Oil, metals, food articles and precious metals have all fallen in double digits over the year, most touching multi year lows. There was absolute risk aversion through out the year much more than what we have seen in 2013 due to Taper Tantrum.
In all this, India stood out. Indian currency and equity markets fell but they relatively outperformed the emerging & Asian market peers. It can be stated that India is out of “Fragile Five”.
We stand at the beginning of a new year and try to look into the future. It is reasonable to expect that the Year 2016 would see yo-yoing of risk perception in the global markets. We believe that India would perform relatively better than its peers.
On the global front, the first major driver for the markets would be on the trajectory of Feds fund rate post the first hike this month. We believe that trajectory would be shallow and totally data dependent. This implies that it would be the “Loosest Tightening” ever for US. Since Fed would not rock the cradle of growth they nurtured for over seven years, the US economy & markets could be strong.
The second major driver would be China where the rebalancing of the economy from investments to consumption is on. It’s GDP growth has been slowing down for five years and it would continue for a few more years. We expect a soft landing due to the tools available with the central bank like forex reserves and reserve requirement ratio (RRR). The good news for India is also that the trade similarity with China is low and hence the impact from the latter is low. Also, slow down in China implies lower commodity prices which would help India in building its infrastructure.
Thirdly, for the first time after many years would we see a diverging monetary policy in the world – US would be in tightening mode while ECB, BoJ and China would be in loosening mode. We expect that the quantitative easing from ECB & BoJ would keep the global liquidity buoyant to more than offset the tightening of the US.
It is a new normal for world growth and inflation. The world would grow at 0.6% slower in next three years than what it was growing for the past 15 years with inflation slowing by 0.8%.
Emerging Markets (EM) will be growing at 1.5% slower with inflation slowing by 1.4%. In the low growth – low inflation world, India stands out with a 7.5% GDP growth & 5-6% CPI (both expectations) for next year and slightly faster for subsequent years. The higher growth potential in addition to strong macro fundamentals, focused monetary policy and stable government would help India decouple from EM basket.
Post 2013 Taper Tantrum period, RBI has focused its monetary policy to contain CPI and government to contain Current Account Deficit (CAD). Both were able to achieve that with significant support from the falling commodity prices.
- We expect the CPI to be marginally up from current level of 5%.
- WPI which has been in the negative territory would bounce back to positive zone – good news for corporate India as it will assist in top line growth.
- CAD will be reasonable at 1.3-1.6% of GDP.
- RBI has cut 125 bps on repo rate in 2015 and we expect 25-50 bps further rate cut in 2016.
- The banks have transmitted 70 bps or lower to their borrowers. We expect a further transmission of 50-75 bps primarily due to rate cuts and change in base rate formula. This will be good for the corporate sector as cost of borrowing reduces, its interest out go reduces and credit requirement from the system improves.
India’s GDP would be driven by two engines – Govt. Expenditure and Consumption.
The government has given higher budgetary allocations to some of the capex heavy sectors and would continue to do so in coming years. The allocation to five sectors – Roads, Railways, Defence, Smart cities and Renewable energy would go up 2.5 times in next five years compared to previous five years. Some of the execution models were changed, new sources of funding used and challenges in execution removed.
Government has been able to achieve quite a few things like auctioning natural resources successfully, resolving taxation issues for FPIs, opening FDI route to various sectors, financial inclusion using Aadhaar cards & bank accounts, transfer of benefits like fuel subsidy & scholarships directly into bank accounts among others. It has also initiated quite a few policies which are work in progress. For instance, the UDAY scheme to resolve the debt issue of SEBs which is currently joined by ten states. Indradhanush to recapitalize PSU banks and make them stronger by implementing some structural changes. GST bill to ease doing business in India by simplifying tax structure. There is also healthy competition among states to attract capital for investments. The political parties have realized that the reward for developing their states is a chance to get re-elected.
On the consumption front, we believe that it would be driven by urban consumption driven by lower EMIs, higher real wage growth and increased job security & opportunities. There are some of the high frequency data points which point to green shoots like the growth in airline traffic, oil consumption, domestic CV and naukri jo speak index. The coming year will also see implementation of 7th pay commission by the central government, state governments and PSUs. A total of 25 mn (approx.) employees & pensioners will receive over Rs. 3.8 trillion in hand. This would pump up discretionary demand as in the case of the 6th pay commission and sectors like cars, two wheelers, ACs, apparel, footwear and housing would get benefited.
In terms of flows, FPI follows into equity were tepid. It hit a four year low of USD 3.6 bn. These flows could rebound as and when the global stability emerges. However, the DII flows have been the strongest in seven years with a net inflow of USD 9.1 bn. These are primarily driven by mutual funds which have seen inflow for 19th month in a row. As financial savings increase moving away from physical savings, continued flow into equities from DIIs is expected for a long time. Through the FDI route, India has seen record flows this year – USD 26.7 bn in nine months, due to attractive investment opportunities the country provides.
On the earnings front, for the past six years, the market participants have been expecting strong earnings growth at the beginning of the year only to downgrade steeply by the end of the year. In FY16 also, earnings were expected to grow in high double digits only to see a revision to single digit growth after two quarters.
This was at the back of four factors –
- Back to back monsoon failure leading to rural slow down,
- Dis-inflationary impact on corporate India due to falling commodity prices,
- Slow transmission of interest rate cuts and
- Issues with business execution with a couple of companies.
Going into FY17, these factors could reverse. It was the fourth time in 115 years that we have seen back to back monsoon failure and there has never been a triple monsoon failure. Statistically, monsoon should be normal in 2016. With deflationary pressures easing off, we expect nominal growth to resume. Only 70 bps of the 125 bps policy rate cut has been transmitted into the system and that too in the second half. FY17 will see full benefits of this transmission along with further transmission due to base rate formula change and rate cuts. With these in mind, we expect that the trend could reverse in FY17 to clock earnings growth of 17% with a high degree of probability.
With reasonable valuations and earnings growth, Indian markets provide an opportunity for sustainable long term wealth creation. Though there could be bouts of volatility, we believe a patient association with equity will be rewarding. The key themes we expect to play out are Consumer Discretionary, Private Banks, NBFCs, Pharmaceuticals and Construction.
While Equities as an asset class has performed well in short period (3 years), it has lagged in medium term (5 years). There are enough triggers for it to mean revert to long term returns (20 years). At the same time, there are structural factors at play which may slow investments in other asset classes like Fixed Deposits, Real Estate and Gold.
Like the story of the wood cutter who stops to sharpen his axe to cut timber better, India is doing the all the right things “Strengthening the core” for consistent and sustainable long term growth!