It was 8 am on May 23 when the designated officers of the Election Commission started counting the votes to the General Elections 2019. About two and half hour later, the benchmark stock market indices — Sensex and Nifty — skyrocketed to touch the historic highs of 40000 and 12000, respectively. Reason: Narendra Modi-led Bharatiya Janata Party (BJP) was set to return to power to the Centre for the second time.
Though, by the end of the day both the indices had retraced its steps to close lower, the frenetic pace in which the markets moved in the early hours could be a glimpse of positivity among investors on the hope of a stable government.
Markets had witnessed muted gains in 2018. However, in 2019 powered by foreign inflows, large cap indices touched their all-time highs with gains of more than 8 per cent year-to-date, making India one of the best performers in the emerging markets space since March. In fact, large cap indices surged more than 3.5 per cent in the week ended May 24 alone.
Investors, especially foreign players, reacted positively to Modi’s victory and pumped more money into the markets. Market participants are currently hoping that this clear mandate will allow Modi’s second term in office (Modi 2.0) to push through major reforms, which will help improve the long-term growth prospects of the economy.
With major event risk of elections out of the way, Modi’s focus now would be on a couple of things. One is the composition of his cabinet and the second are the immediate challenges the economy faces. The budget will hog the limelight in the beginning of July.
During Modi’s first term, significant progress had been made on the macroeconomic front and important numbers like CPI and fiscal deficit were well in control. In 2013, CPI stood at 11.5% versus the current reading of 2.57%. Fiscal deficit, which was at 4.60% of GDP in FY14, has come down to 3.40% of GDP in FY19.
Now, the government will focus to reduce the deficit number further in line with the new FRBM Act. However, promised populist measures and tax sops given to lure voters shall lower revenues in the near term and balancing revenue collections and expenditure will be a challenge for the new team.
One of the major tasks for the new government will be to boost the slowing economy which fell to the lowest level in five quarters. Declining industrial and manufacturing output growth, slowing car and two wheeler sales are major worries which need to be addressed. In order to boost the consumption, additional sops to individual tax payers and MSME may be provided. The government and the banking regulator also need to address the ongoing liquidity crunch which is showing its impact on other major sectors.
The RBI needs to do more to boost liquidity; India has among the highest real interest rates giving it room to be dovish. The RBI needs to make sure its policy rate cuts are passed on to end users which can also act as a catalyst for economic recovery. The RBI policy in June will be keenly watched to know the central bank's rate stance. If the RBI can return some of its excess to the government, it could be used to recapitalise banks which can boost credit growth.
The government aims to boost the economy to $5 trillion by 2025 and double the farm income by 2022. While easing rural stress may be an immediate need, major reforms are needed to boost farmers’ income in the long term. Rolling out the National Agriculture Market and the mechanism of connecting all agricultural markets across India will boost farmers’ income. Encouragement of cold chains and providing subsidiaries for them would help the agriculture sector. Better irrigation facilities shall improve farmers’ yield across the nation. Adoptions of food safety, quality assurance mechanism and implementation of Minimum Support Prices will further boost the rural economy.
Other areas to focus and improve are real estate, capital goods and infrastructure. With the government likely to get a majority in the Upper House of Parliament in 2020, modification and amendment of the Land Acquisition Act of 2013 is likely. While implementation of RERA has improved transparency and the trust of home buyers has increased, reduction of GST rates, incentivising developers to promote low cost housing and subsidising new home buyers could be one of the major steps to achieve the target of Housing for All by 2022. PMAY (Pradhan Mantri Awas Yojana) aims to support 2 crore homes in urban and rural areas through financial assistance from the central government. The interest subsidy through this credit linked subsidy scheme is able to identify the right beneficiary and also plug leakages.
During Modi’s first term, energy deficiency came down significantly from 8-10% in 2013 to 0.70% in 2017-18. The push for addition of thermal and non conventional sources has increased electricity production. The ambition of 175 GW by 2022 can be achieved as research shows that installations of solar projects have surpassed installations of coal based power projects in 2018.
In its manifesto, NDA has talked of increasing capital investments especially in areas of water linkage, rail and road connectivity and this can pump prime the economy.
For equity markets to make progress, the government needs to effectively tackle the immediate challenges. However, there are external challenges as well with uncertainties over trade war and geopolitical tensions threatening oil supply. The trade war between US and China may result in some manufacturing units moving to India but this will take a few years. Meanwhile, the trade war is unhelpful for the global economy and the short term impact on India is negative. Despite challenges, the Indian economy is resilient which makes it attractive to foreign investors.
From a valuation stand point, we are placed at 18.5x of 12 month forward earnings. There is some more upside for Nifty to rally from here, but the key short term challenges on the domestic and global front shall restrict the upside in the near term. Factors like the resolution of the liquidity crunch, shape of the cabinet, RBI policy, budget, monsoon and its impact shall be the key drivers for the near term.
From a long term point of view, investments in consumer companies, rural financing companies, cement, infrastructure, building materials, insurance, agriculture and farm equipment companies are likely to do well.