Big Sensex rally in 2016 unrealistic - said By Saurabh Mukherjea
The rally that began in the Indian
market when Raghuram Rajan took charge of the Reserve Bank of India (RBI) in
September 2013 lasted until March when the Sensex hit 30,000 points. The first
12 months of this rally were largely driven by foreign institutional investors
(FIIs) as they loaded up on India in the run-up to the 2014 general election
and for a few months thereafter. However, by the early months of 2015, FII
equity inflows began to peter out as corporate earnings growth stagnated.
|
|
The last time corporate India
produced such dismal earnings growth was during the 2008 financial crisis.
Today, in spite of poor corporate earnings, share prices have broadly held up,
thanks to retail investors' optimism. To put things into perspective, since
May, FIIs have sold local equities worth Rs 45,700 crore, whereas domestic
institutional investors have bought stocks worth Rs 51,900 crore as of
November.
So, what's going on? Why are FIIs
losing their enthusiasm for Indian equities even as they enthusiastically
invest in Indian debt? Why are corporate earnings not growing quarter after
quarter in a country where nominal GDP growth is close to 10%? And given this
predicament, what will 2016 bring?
Modi's resets
Over the course of 2015, we have
repeatedly said that Prime Minister Narendra Modi is trying to reform the
Indian economy along three specific dimensions:
* Altering the subsidy regime-by
cutting subsidies and moving subsidies to the Direct Benefit Transfer
platform-thus adversely impacting rural consumption.
* Signalling to crony capitalists
that it is not "business as usual" for this subset of Indian
businessmen who use lobbying to routinely bend policy in their favour.
* Attacking black money through the
Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act,
2015, which, after a 90-day amnesty window expires, punishes Indians who have
undisclosed wealth abroad with a 10-year jail sentence.
How structural reform impacts
economies
Structural reform usually entails
short-term pain as economic agents (workers, bankers and business people)
struggle to cope with the altered rules of economic adjustment. Britain under
Margaret Thatcher, India after the 1991 reforms and Indonesia after the East
Asian crisis give us a clear picture of what is likely to happen to India as
Prime Minister Modi's economic resets hit home:
* In the UK, Thatcher began the
economic reform process in 1980. Gross domestic product (GDP) initially
contracted 2% due to these reforms, but then recovered from 1982 onwards. In
particular, investment initially suffered under Thatcher as she kept monetary
and fiscal policies tight. As inflation expectations were brought down, private
investment gathered pace.
* In India, economic reforms began in
1991 in the wake of a balance of payments crisis. GDP growth fell to 1% in
FY1992 but then recovered from FY1993 onwards.
* In Indonesia, reforms began in 1997
in the aftermath of the East Asian crisis, the economy shrank 13% in 1998 and
investment collapsed. Then, on the back of large currency devaluation and more
freedom for smaller businesses, investment gradually recovered from 2000
onwards.
These examples have a common feature:
economic growth and investment nosedive during the initial phase of reform, as
the rules governing the economy are radically altered by reform and economic
agents struggle to adjust to this change. Gradually, the reforms put the
economy on a sustainable growth path as against the growth fuelled by excessive
government spending (as was the case with Britain in the 1970s and India in the
1980s) or by unsustainable external funding (as was the case with Indonesia in
1997).
Impact on the economy
In light of the above, in August, we
downgraded our GDP growth estimate for FY2016 from 7% YoY to 6.8% YoY, well
below the consensus estimate of 7.5%. We have since said that we do not expect
GDP growth to improve materially in FY2017. Our sub-consensus view on GDP
growth translates into a corresponding view on earnings growth, which in turn
leads us to believe that over the next 12-18 months, it is unrealistic to
expect the Sensex to rally by more than 10-15%.
In fact, given the elevated level of
stress in the Indian banking system, combined with the gradual deterioration of
the gigantic Indian real estate sector, there is a real risk that the Sensex
could go as low as 22,000 points, especially if the rupee comes under pressure
in the wake of further devaluation of the Chinese currency. Hence, if you are
considering investing in Indian stocks, we would suggest that you focus on
high-quality franchises that are available at reasonable valuations. More adventurous
investment strategies are unlikely to be rewarding in the current economic
climate.