Global events dominated 2016 and we continue to see a similar trend going into 2017. We believe 2017 is going to be a year of contrasting performance with the first half being more challenging, driven by domestic and global events and the second half seeing a sharp recovery.
On the global front, we see more rate hikes by the US Federal Reserve after Donald Trump's win in the US Presidential elections and expected fiscal boost by his administration. A strengthening US dollar along with higher commodity prices may impact the near-term growth and corporate earnings in emerging markets. We also see a greater risk of a currency devaluation in China which could further impact other emerging market currencies, including the Indian rupee. With Europe’s largest economies electing new governments over the next 18 months, political uncertainty could periodically impact the markets.
Back home, the growth/demand slowdown caused by the government’s recent de-monetisation drive may get further accentuated once GST is implemented. While GST may cause a near-term slowdown on account of the complexity and the scale of implementation, we believe the unified system of taxation will be very positive over the long term as it aims to simplify the existing indirect tax structure, prevent cascading of taxes, remove inter-state barriers and formalize a greater part of the economy. This will eventually lead to higher GDP growth, lower inflation and higher government tax revenues on account of increased compliance.
Demonetisation, GST and other government measures to curb the black money generation will eventually lead to a higher Tax/GDP ratio. This would help in boosting government revenues and support higher capital expenditure and lower the fiscal deficit.
The rupee continues to remain one of the most stable currencies since the EM currency sell-off in August 2013 and we believe the RBI will continue efforts to maintain currency stability. At Rs. 68.07/USD, the currency is overvalued on a real effective exchange rate (REER) basis and we believe it will gradually move toward its fair value. This should be positive for export growth. A stable INR should bode well for foreign flows. Favourable terms of trade, strong reform focused Government and good macro environment will offset some of the potential currency weakness triggered by the US dollar strength.
Benign inflation should allow the RBI to further cut interest rates in the coming year.
Foreign institutional (FII) flows have been muted in 2016, with net inflows into Indian equities of USD 3.2 billion as the dollar strength has resulted in money flowing back to developed markets from emerging markets. This is much below the previous 5 year average of USD 13.5 billion (per year) and the peak inflow of USD 29 billion in CY2010. We believe 2017 could see higher flows from foreign institutions as money comes back to growth markets like India. Flows from domestic institutions, on the other hand, have outpaced foreign flows for the second consecutive year and we believe this trend could continue in 2017. Lack of investment options (gold/real estate) will lead to a faster shift in savings from physical assets to financial assets.
We believe that the steps taken by the government are in the right direction and the benefits of the same will be visible over the next few years. After a near-term slowdown on account of de-monetization, GDP growth will likely bounce back in the second half of FY2018.
We expect corporate earnings growth to improve from the second half of FY2018 as the headwinds of the last few years (lower commodity prices, higher banking system NPLs and lower Government/private capital expenditure) could turn into tailwinds.
On equity markets, we believe 2017 will be a strong year after almost two years of negative returns. Attractive equity valuations relative to bonds, stable currency, policy reforms and stabilising global growth bodes well for equity returns this year.
A pickup in corporate earnings growth, full transmission of lower interest rates and expanding return on equity (ROE) for corporate India will be the medium to long term drivers for equity markets. Within portfolios, we expect value stocks to outperform growth stocks in 2017. In summary, we believe that the Indian equity market is a good structural opportunity and our outlook is positive for 2017. The author is an Executive Vice President at DSP BlackRock Investment Managers
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