Sanjay KumarPNB MetLife
The year 2016 has been an eventful one for the economy as well as markets led by a mix of global and domestic factors. Globally, Britain’s decision to exit from the European Union, followed by Donald Trump’s victory in the US Presidential elections, came as a big surprise for global economy as well as markets. This, coupled with monetary policy tightening by the US Fed, expansive global fiscal policies and signs of growth recovery in developed economies, led to hardening of global bond yields. This created a risk-off environment in emerging markets and consequent flight of capital to safe havens towards the later part of 2016.
Back home, it was demonetisation that has temporarily disrupted the discourse of a gradual consumption-led domestic economic recovery. This took both equity and fixed income markets by surprise even as the broader economic growth outlook remains unchanged.
Going into 2017, we expect the ongoing volatility to continue for some time now. On the macro front, temporary disruption in cash transactions due to demonetisation is likely to hurt domestic demand for a couple of quarters, especially for discretionary items. This may result in economic growth slowdown, with the Central bank expecting FY17 GVA growth at 7.1% vs. its earlier estimate of 7.6%. Barring the near-term pain, we remain constructive on India’s consumption story and expect economic growth to come back in the second half of 2017.
Inflation is likely to remain comfortable amid interim demand slowdown due to demonetisation. This is likely to keep the RBI monetary policy stance accommodative. However, upside risks to inflation could emerge in 2017 from a) potential firming up of crude oil prices following OPEC’s agreement to cut production and b) INR volatility arising from global developments such as US monetary and fiscal policies.
The government’s focus on implementing structural reforms is expected to continue. Some of these reforms include formalising the parallel economy, reducing incidence of unaccounted money, removing infrastructural bottlenecks and strengthening governance. The much-awaited goods and services tax (GST) may see light of the day in 2017. Barring short-term disruptions during the transition period, GST is expected to benefit the economy substantially in the medium to long-term.
Further, we expect increased public spending on the rural economy (especially low-cost housing) and infrastructure, facilitated by additional tax revenues generated through Income Disclosure Scheme. This is likely to support economic growth in FY18 particularly in the wake of weak private sector investments.
Equity markets, after a huge rally between March and August 2016, fell in the later part of 2016 on account of significant foreign capital outflows following Trump’s win. Further, short-term adverse implications of demonetization on economic growth and corporate earnings added to the market woes.
Uncertainty over US trade and fiscal policies, impact of demonetisation, government’s fiscal stance and upcoming legislative assembly elections in Uttar Pradesh may keep equity market volatile in the near-term. Corporate earnings are likely to remain muted over a couple of quarters. However, a rebound is expected in FY18 facilitated by a pick-up in economic activity, lower interest rates and favourable base. Moreover, after the recent correction, market valuations appear reasonable given the undergoing structural transformation of the economy.
Further, expected shift in household savings from physical to financial assets, amid reduced relative attractiveness of real estate and gold
post demonetisation, bodes well for equity markets. As such, barring near-term volatility, equity markets appear attractive from a medium to long-term perspective.
Fixed income market saw a huge rally in 2016, initially led by declining global bond yields and later by ample domestic liquidity and expectations of a dovish RBI post demonetisation. The rally was largely driven by domestic participation while foreign portfolio investors were net sellers in 2016.
In fixed income market, the government’s commitment to fiscal consolidation, growth-inflation dynamics and INR volatility will have a bearing on domestic bond yields. Further, global cues such as actions and commentaries of global central banks, particularly US Fed, and movement in crude oil prices are crucial factors for domestic bond yields. Meanwhile, with banks benefiting via lower cost of funds due to surge in deposits, monetary policy transmission is likely to continue in 2017.
Overall, barring temporary disruptive growth effects, we remain positive on India’s macro-economic fundamentals. We expect the government’s strong focus on transforming India to lead to a long-term structural growth story.