The market is pricing in a reform-oriented stable government, pivoting around one national party.
Market sentiment in the near term will be influenced by the election outcome. The market couldn’t predict the actual election outcome in 2004 as well as in 2009. It got lucky in 2014. Election results matter and affect markets at the time of announcement. In 2004 as well as in 2009 unexpected outcome resulted in significant movement in the market.
Today the market is pricing in a reform-oriented stable government, pivoting around one national party. There will be material move on the day of the result if the actual outcome is different. Post-election, the market will be driven by fundamentals. In May 2019, an unexpected result will make a material impact on the market as it did in 2004 and 2009, but after that fundamentals will take over.
From a fundamental viewpoint, FY20 earnings growth could jump, owing to corporate focussed banks, generic pharma companies and firms having a presence in Europe. Telecom sector could be a surprise if the ongoing telecom war comes to an end.
From the headline point of view, 3Q FY19 GDP growth slowed to 6.6 percent. Auto sales in February were down by more than 7 percent. The auto sector is cutting production to manage higher inventory. FMCG and consumer durable companies are witnessing demand deceleration. Tractor Firms are talking about a deceleration in the rural economy. Goods and Services Tax (GST) collections are coming below the budgeted run rate.
Why is market ignoring signs of deceleration?
In our opinion, the market is discounting such news as a slowdown in growth and not negative growth. The reference here is about below potential growth and not negative growth. India is still the fastest growing major economy in the world.
The below potential growth is a function of multiple factors. For one, the formalisation of the informal sector due to disruptive reforms like demonetisation and GST have changed the business model resulting in the inevitable slowdown.
The government in the last few years pursued the path of fiscal prudence, which combined with tight monetary policy, adversely affected the growth potential like a car slowing down with combined effect of brake and hand brake.
The market is now pricing that the liquidity situation will improve as cash will return after the election. The RBI, having brought inflation to the lower end of the comfort zone, will keep appropriate liquidity to support higher growth. The cost of credit was relatively higher as RBI battled Inflation and inflationary expectations. The government of India is borrowing at more than 4 percent real interest rates.
Higher real interest rates have brought inflation from double-digit to a lower single digit, but have kept growth below potential. The market is pricing in sharp rate cuts to bring down the cost of borrowing. The transmission of credit was restricted to sectors like SME, real estate and Infrastructure, especially from PSU banks which were placed under the PCA framework. Post ILFS default most of the NBFCs scaled down their lending, creating credit squeeze leading to below potential growth. The market is pricing in that PSU banks will get adequate capital from the transfer of reserve from the RBI. The improved credit flow post capitalisation of PSU banks will push growth to the potential level.
The Market is hopeful that growth in the coming period may be supported by better credit with appropriate liquidity condition, reduced real interest rates and effective rate transmission. A stable government is likely to strengthen the entrepreneurial environment, improve the ease of doing business, and ensure minimum government and maximum governance.
The road to fiscal prudence is likely to be maintained by raising resources through strategic divestment and asset monetisation. The monetary policy is likely to be more growth-oriented as inflation may remain subdued. All this will result in better earnings growth in the days compared to what has been witnessed in the past. The task is cut out for the new government, RBI, judicial authorities, bankers and entrepreneurs to push growth back to potential level.Nilesh Shah is managing director at Kotak Mahindra Asset Management Co Ltd. Views are personal.
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