Wondering what next? Ignore the near-term turbulence and stay put

In my view, the stars are stacked against the Indian economy and therefore the market. It will take a very strong political will, economic acumen and divine help for us to get out of this situation.

It is not looking good

I do not accord much significance to the aggravating Russia-Ukraine conflict. My understanding is that this conflict has been persisting at least since the disintegration of the USSR. The hostilities deepened in 2014 when Russia annexed Crimea, one of the key Ukrainian provinces.

I believe this local conflict would continue, with Russia and NATO supporting the opposite factions with money and arms for years, as was the case with Afghanistan.

My premise is that the situation for the Indian economy was bothersome even before this geopolitical issue aggravated. This conflict has only added a couple of new dimensions to the problem.

The 3QFY22 GDP data is not an exception. This reflects the trend of structurally slowing growth that will continue well into FY23 and even FY24. Even the Reserve Bank of India has forecast less than 5 percent growth for 2HFY23 when Covid-19 base effect subsides.

Also read: February GST collections decline to Rs 1.33 lakh crore, down 5.6% from January

India’s tax to GDP Ratio is the same as 2007—no improvement in the past 15 years. However, the interest payments to GDP have grown by more than a third from 5 percent to 6.5 percent of GDP.

As per FY23BE, the Centre will spend more than 20 percent of the budget only on interest payment. Obviously, the budget for development, social sector spending and subsidies is contracting.

Given the elevated inflation and negative real yield on savings; higher indirect tax burden on middle and lower middle class, and lower social sector spending/cash payouts – the consumption has been hit. There is nothing to suggest that there could be any reversal in this situation anytime soon.

Also read: GDP growth slowed to 5.4% in Oct-Dec 2021, FY22 growth estimated at 8.9%

Fuel on fire

To make matters worse, the government is facing a global geopolitical crisis. Russia and Ukraine are not only large suppliers of oil & gas but also edible oils.

A substantial part of India’s edible oil import also comes from these two countries. A disruption in the supply chain (due to war or sanctions) could lead to rise in edible oil inflation, further hurting households.

The market price of transportation fuel and cooking gas has not been revised since November, apparently to suit political convenience.

Also read: ATF price hiked by 3.3%; fifth increase this year

Natural gas and crude prices have risen substantially since. Sanctions on Russia may cause a further sharp up-move in global energy prices. This is a Catch-22 situation for India.

If the government decides to pass on fully the crude prices to consumers, inflation may see a spike and consumption demand collapse further.

On the other hand, if the government decides to take a hit on fiscal, the deficit, borrowings and interest burden will rise substantially over the budget estimates. This will happen when the non-tax receipts from disinvestment, etc may not materialise and revenue expense may rise due to dearness allowance, etc.

Obviously, the primary premise of the budget—a sharp rise in capital expenditure—will collapse. Global agencies will put sovereign rating under review, making the cost of borrowing even higher. Financial stress may rise, abruptly ending the asset quality improvement cycle for banks.

This all may keep FPIs motivated to continue dumping Indian equities and debt, pressuring the current account and the rupee.

Higher inflation, lower incomes, weaker INR and higher cost of capital—this all is plausible together for some time.

Also read: Eight core industries grow at 3.7% in January

In the words of Mirza Ghalib: “था ज़िंदगी में मर्ग का खटका लगा हुआ, उड़ने से पेश-तर भी मिरा रंग ज़र्द था (My life was always under threat; I was doing poorly even before this crisis).”

To answer the first question, “Abhi toh achha nahin lag raha hai (For now, it is not looking good).”

So, what to do?

It is important to note that there is virtual stagflation in the domestic economy, constraining private consumption. Exports have helped in the past couple of years to some extent. However, the higher probability of slowing growth in the west due to tightening monetary policies, the spectre of a prolonged geopolitical conflict in Europe and probable reorganisation of the global order (political realignment, trade blocks, currency preferences and energy mix, etc) will cloud the export growth in FY23.

Another key driver of growth has been public expenditure. The government made decent cash payments to the poor and farmers to support private consumption. It also accelerated the expenditure on capacity building, to compensate for the slower private investment.

From the FY23BE it is clear that the government’s capacity to support the growth is now limited by fiscal constraints.

What does this mean for the equity markets?

In my view, the following 10 themes have been the primary drivers of the Indian equities in the past five years:

1 Larger well-organised businesses gaining market share at the expense of smaller poorly organised businesses. Demonetisation, GST and Covid-19 have aided this trend, which has been seen across sectors and geographies.

2 Import substitution and make for exports. Many sectors like chemicals, pharmaceutical (API), electronics, food processing, etc have built decent capacities to produce locally, the goods that were largely imported. Some global corporations have increased their domestic capacity to address the export markets from India. Many Indian manufacturers have also built material capacity to address the export markets. The government has aided this trend by providing fiscal and monetary incentives.

3 Implementation of Insolvency and Bankruptcy and some ancillary provisions, gave impetus to the resolution of bad assets and material improvement in the asset quality of the financial lenders.

4 Persistently negative real rates, stagflationary environment, business stress for smaller proprietary businesses and significant losses in some debt portfolios motivated a large section of household investors to invest in equities for augmenting their incomes and even protecting their savings.

5 Increase in rural income due to cash payouts by the government, higher MSP for crops, better access to markets, etc.

6 Increasing popularity of digital technology, driving efficiency for traditional businesses and facilitating numerous new businesses (Etailers, Fintech, B2B and B2C platforms, incubators, etc) that command significantly higher valuation than their traditional counterparts.

7 Overcapacity in infrastructure like roads and power, where traditionally India has remained deficient, resulting in higher productivity and better cost efficiencies for businesses.

8 Aspirational spending of the Indian middle class outpacing the essential spending, resulting in higher discretionary spending.

9 Climate change efforts prompting higher interest in clean energy and electric mobility.

10 Cut in corporate tax rates leading to a higher PAT for numerous companies.

To decide what to do next, an investor needs to assess how the economic, financial and geopolitical situation will:

>> Impact these drivers of Indian equity markets?

>> Impact the earnings forecasts for FY23 and FY24, which basically hinge upon the operation of these drivers?

The assessment will also have to factor in whether the impact, as assessed above, will have an endurable impact or it will be a passing reflection.

In my view, it will just be a passing reflection and these drivers of the Indian equity market will endure in the medium term (three to four years).

Therefore, I will mostly ignore the near-term turbulence and stay put. I will:

>> Follow a rather simple investment style to achieve my investment goals. It is highly likely that this path is boring, long and apparently less rewarding but in my view, this is the only way sustainable returns could be obtained over a longer period of time.

>> Avoid taking contrarian views.

Take a straight road, invest in businesses that are likely to do well (sustainable revenue growth and profitability), generate strong cash flows; have sustainable earing; timely adapt to the emerging technology and market trends, and, most important, have consistently enhanced shareholder value. These businesses need not necessarily be in the “hot sectors” and these businesses may necessarily not be large enough to find place in benchmark indices.

Of course, there is nothing proprietary about these thoughts. Many people have often repeated it. Nonetheless, I feel, like religious rituals and chants, these also need to be practised and chanted regularly.

And if you find a contradiction in the views about the economy and the markets, I politely disagree.