Nifty at 11000

Sanjiv Chainani
Mr. Sanjiv Chainani is the Managing Director of Value Line Advisors Pvt Ltd.

India’s rating upgrade to propel Nifty 50 to 11000 mark

Indian equities have been rising consistently since December 2016. Nifty 50 has been moving up steadily from 7900 levels in the span of 11 months without any meaningful correction. This one-way rally is making investors nervous about the sustenance of rich valuations. On the other hand, corporate earnings have failed to keep pace with the rising markets, making equities look pricey on the basis of P/E ratio. Nifty is now quoting at P/E of 26 times on a historical earnings basis, which is at the higher end of the long-term trend.

Is this scenario likely to change in the near term? Let’s check.

Not so long ago – just about a few years back — we were living in a completely different India. Government finances were in the doldrums; macros were out of shape; inflation was sky high, and so were the twin deficits. Corporate India was struggling, with high interest rates, huge debts, tight liquidity and low demand for goods and services. Raising capital was tough. India’s banking system was struggling with high NPAs and low capital adequacy ratios. Core sectors of the economy, such as iron and steel, infrastructure, engineering & capital goods were under stress. India was grappling with policy paralysis due to expose of numerous scams. There was no resolution in sight. The investment activity was at multi-decade low. Rupee was falling. Investment sentiments were at rock bottom levels. Global rating agencies had placed India at just one step away from junk rating. And a Deutsche Bank research report had placed India among the fragile five economies.

During the last three years, India has changed dramatically. There is a stable political environment, with strong and dynamic leadership at the Centre. A bold and credible reform push by the government has helped to improve the macro-economic landscape. The improvement in macro factors has already panned out over the last 24-36 months as inflation, while the twin deficits are under control. Lower crude prices have played a major role in improving the government’s finances. The investment cycle has turned and corporates are able to raise funds through primary issuances. Forex reserves are also near all-time highs. And, despite various global headwinds, rupee has remained fairly stable.

India has managed to build a strong base, with benefits from savings derived from lower crude prices being put to productive use, such as infrastructure development. Global rating agencies in their past reviews had decided to maintain a status quo on India’s sovereign ratings citing multiple concerns. This is bound to change sooner than later. There are multiple factors which present a strong case for a rating upgrade for India.

The World Bank had recently acknowledged India’s reforms push by placing India amongst top 100 countries on ‘Ease of Doing Business’ rankings list from 130th rank earlier. This is the highest ever jump by any country in the history. This will go a long way in increasing confidence among international investors on India as an investment destination.

During the past 12 months, Indian economy has faced multiple headwinds – be it demonetisation of high value currency notes announced in November 2016 or systemic impediments from the roll-out of India’s largest indirect tax reform – GST – in July 2017. These events have dragged the economic growth, as they have proved disruptive to business growth. Despite these impediments, the Nifty has gone up by 25 per cent in the current calendar year.

Demonetisation has been termed by critics as a big failure, as almost all of demonetised currency has managed to find its way into the banking system. This compares poorly with the initial estimates of Rs3-4 lakh crore, which forms about 20-25 per cent of the demonetised currency not coming back into the system. But, looking at the positive side, this event has expanded the base of the formal economy. It has helped in increasing the tax base, as can be seen from the number of IT returns filed for 2016-17. The number of returns filed has risen by 25 per cent, leading to 41 per cent increase in tax collections. It has helped in promoting digitization, as the number of digital transactions has gone up multifold post-demonetisation. Various fin-tech technologies have evolved in the back drop of government’s digital push.

Additionally, the cash which was lying idle is getting channelised into productive asset classes routed through the banking system. Increase in bank deposits has led to lower deposit rates. Investment demand for real estate has collapsed. Lower inflationary pressure has reduced investment demand for precious metals. There is a dearth of high yielding investment options for investors. Investors have started looking towards equity as an asset class. There is ample flow of domestic liquidity, which is finding its way into equities through mutual funds and direct equities. Assets of equity mutual funds have increased by 46 per cent y-o-y, crossing the Rs7 lakh crore mark for the first time, in October 2017.

The clean-up activity post demonetisation has resulted in the closure of numerous shell companies and disqualification of dubious directors. BSE has compulsorily delisted 200 companies and have barred promoters of these companies from accessing securities market for 10 years.

GST is another major reform implemented by the government with the view to simplify indirect taxation, improve compliance and broaden tax base for the government. India is the one country with the lowest tax coverage. GST has managed to bring a majority of the businesses under its purview. In the years to come, India’s indirect tax revenues are expected to jump manifold, resulting in a higher tax-to-GDP ratio.

A hasty roll-out of GST in July 2017 has been criticised by the Opposition and the industry bodies, as it has led to disruption in business activities. The impediments in the GST rollout – be it systemic issues, technical glitches, compliances and processes — are being addressed responsively. The government has recently reduced GST rates on 178 items. It has hinted at more GST rate cuts in the future too, depending on the revenue buoyancy.

Aadhar has proved to be a game changer for India. It has reduced leakages and has helped channellise resources to the targeted section, by directly crediting thamount into beneficiary’s bank account. It has covered entire population into formal system. The World Bank, in its ‘digital dividend report’ published last year, has estimated that, if Aadhaar is used in all Indian government schemes, it will accrue savings of $11 billion every year.

Insolvency & Bankruptcy Code (IBC), a newly enacted bankruptcy law, aims for resolution of the insolvency cases in the strict time-bound manner. This path-breaking reform is expected to provide solution to the NPA problem for the Indian financial services sector.

Recapitalisation of the PSU banks by way of recap bonds of R2.11 lakh crore is another bold initiative taken by the government of India, which will help push economic growth. It will assist capital-starved PSU banks in improving their credit growth as compared to well-capitalised counterparts. It will also make easier for them to raise fresh capital by tapping capital markets. The government has already shifted gears, as election season is kicking in. Many states are going into elections in the next 12-15 months. The Lok Sabha elections too are due in mid-2019. Historically, the economy is seen to pick up sharply during election period. If the ruling government manages to win key state elections, it will further improve their tally, closing in on a majority in the Rajya Sabha. This will give a further boost to the reform agenda of the government.

The government has already started spending in real sectors to provide a boost to the economy. It has announced Rs14 lakh crore of capex plans over next five years in key infrastructure sectors such as roads, power, railways, digital, and housing. This will have a significant multiplier effect on demand and employment. This massive capital spending by the government will provide boost to core sectors such as cement, auto, metals and mining, capital goods, engineering, construction etc. Indigenization of defence sector is another huge opportunity which will pan out over the years.

Analysts are concerned about the lack of earnings growth. The analysis of the results of the quarter ended September shows that the results are broadly in line with the estimates with lesser downgrades. After the macro story has panned out, it is now time for the micro story to pick up. As earnings start picking up from the next year, market valuations will also start looking attractive.

There are multiple uncertainties in the near term, which is weighing on the market sentiments. After falling continuously for months, Inflation has started showing signs of hardening, which can partly be attributed to rising food and fuel prices. The risk of rising inflation may prevent further fall in interest rates.

Brent Crude has touched $65 per barrel due to geo-political factors, such as political unrest in Saudi Arabia, risk of default of Venezuela, voluntary production cuts by OPEC, etc. These factors are affecting crude prices in the short term. On a long term basis, fundamentally, crude is still in the bear market as global supply growth is estimated to be more than the demand growth as per report published from IEA. Growth in electric vehicles will further keep a lid on demand for conventional fuel.

On the positive side, retail inflation is increasing due to improvement in farmers’ realisations, which will result in higher rural incomes and higher consumption demand in rural India in 2018, which will be good for the economy. India’s sovereign ratings upgrade is imminent sooner than later, which should also act as a huge trigger for the markets to scale to new highs.

This article was originally published in Business India Magazine.
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Disclaimer: The views expressed in this article are personal and the author is not responsible in any manner for the use which might be made of the above information. None of the contents make any recommendation to buy, sell or hold any security and should not be construed as offering investment advice.