While the economy may be on the downward journey, stock markets are firing on all cylinders. For the investors, Sensex at 40,000 is not just a psychologically important mark. Five months ago the Sensex had touched the same number, but that moment of joy was rather short-lived. By mid-September, the index slid and was near 36,000 levels. So, fears of an impending correction may be justified by some participants. While we do not have a crystal ball to predict future stock market movement, many equity 'pundits' seem convinced that the Sensex may rise much higher than 40,000. Why? They cite three potential triggers that can help the Indian stock market build on its recent gains and march forward uninterrupted. Read on to know more.
Trigger 1 - Direct Tax Code
Indian stock markets have already celebrated finance minister Nirmala Sitharaman's announcement of a deep cut of 10% in corporate tax rates for domestic companies. The corporate tax cuts were met with applause as markets had their best day in many years. But, corporate tax cut is merely one reform. India is suffering from a structural slowdown and is suffering from a demand problem. Nobel laureate Abhijit Vinakay Banerjee recently observed that the government's focus should be on reviving demand. The demand puzzle can be solved by putting more money in the hands of the people. Cutting income tax rates will do that job easily. In this backdrop, the Modi government must be open to implement the Direct Tax Code (DTC) and cut personal income tax rates soon.
A task force constituted by the government for drafting the new DTC has already submitted its report to Sitharaman on August 19. The DTC is expected to make personal income tax rates more 'progressive' by giving relief to people in the 5% and 20% slabs. In order to revive a slowing economy, the government's corporate tax cut sop has come at a cost of Rs 1.5 lakh crore annual revenue loss. To pull back the economy from the structural morass, sharp cuts in income tax via the DTC route are a necessity. Some are already rooting for it. India's fourth-largest asset manager expects the Direct Tax Code to boost middle-class income. Aditya Birla Sun Life Mutual Fund MD & CEO A Balasubramanian expects that Direct Tax Code (DTC) which is expected to be announced soon may see a tax reduction for the middle-class income thus providing more cash in their hands boosting sales of auto, consumer durables and consumer nondurable sectors.
Kotak Institutional Equities sees significant gains in the income ranges up to Rs 2 crore with gains of 1-49% across various income levels. Most of the individuals in these income slabs will contribute to leveraged consumption, which will be positive for low-ticket automobiles and consumer durables and FMCG products. Real estate, especially the high-ticket/luxury segment, is unlikely to benefit much from these income tax cuts.
Cutting personal income tax rates, however, will not be easy. The government needs to become flexible with the fiscal deficit number and loosen its grip. As per new tax slabs via DTC, reported in the media, the exercise would likely cost Rs 1.75 lakh crore or 0.8% of GDP, atop 0.7% of GDP released by September's corporate tax rate cut, as per BofA Merrill Lynch Global Research. "There is no doubt that a demand-side measure, like the income tax cut, has a more immediate growth impact than a supply-side measure like the corporate tax rate cut, in our view," says BofA Merrill Lynch Global Research.
Along with the RBI measures and interest rate cuts, a personal income tax rate reduction would help to defuse the 2018 liquidity crunch that has pushed up lending rates and hurt demand. While the government may not want to hurry with personal income tax rate cut given that it cannot roll-back such a measure quickly, the economic scenario continues to be bleak. The muted Diwali festival demand has already shown the consumers are not in a mood to buy. Ignore reports of Mercedes cars and iPhone sales as these luxury items and such items are out of reach for the 'aam aadmi'. Interest rate cuts by the RBI, at the behest of the government, only make loans cheaper. Lower interest rates do not boost disposable incomes. A quick income tax rate cut would likely be feasible only if the government finds itself in a comfort zone about financing the corporate tax rate cut that should lead to fiscal slippage. Selling off PSUs at a good premium can partially help fund personal income tax rate cuts.
Personal income tax rate cuts will straightaway put more money in the hands of the taxpayer, thus giving them a push to consume more. Consumption boost will help trigger a demand wave and thus could be one of the last ways to revive the economic situation. This will boost the corporate sector earnings in terms of higher revenue and thus boost the Sensex in a more fundamental way.
Trigger 2 - Monsoon benefit
India has received normal rainfall during the current monsoon season of June-September 2019. IMD’s estimates indicate that the aggregate precipitation has been 10% higher than the long term average. At a sub-divisional level analysis on rainfall distribution, it is apparent that 77% of sub-divisions have received normal or excess rainfall, which is highest when compared to the previous five years. Such figures do indicate that the rainfall has been satisfactory in most parts of the country.
While one may argue that the temporal distribution of the rains has not been so conducive for the Kharif crop, many market 'pundits' feel that the monsoon benefit is being downplayed. That is why it can be a key trigger for pushing markets and Sensex higher. "This (Monsoon effect) will boost the agriculture and allied sectors. This is, in my opinion, a very underestimated factor as of now," says Balasubramanian, who has nearly three decades of experience.
The favourable monsoon notwithstanding, the food grain production from the current Kharif season will be lower than expected. The impact on the Kharif harvest is not only due to the uneven distribution of rainfall but also on account of a visible change in food cropping pattern, according to Acuité Ratings & Research.
The monsoon rains started late and has continued even till the month of October with significantly excess rainfall in some parts of Western India. This has therefore, not only impacted the sowing of the crops but is also likely to hit the yields and the harvest output in the current season particularly with respect to cereals and pulses. Acuité has further observed that due to the prevalence of lower prices of certain food grains over the past two years, there has been a gradual shift in cropping patterns towards cash-crops. The area sown under cotton and sugarcane is 4% and 9% higher respectively which is well above the normal sown area. Therefore, production for these two cash crops is expected to be high in the current Kharif. We reckon that cotton production, which is critical for the textile industry, will be higher by around 12%. Similarly, sugarcane output is expected to remain high during this period.
"Nevertheless, the higher amount of rainfall in the late half of the Kharif season will augur well for the ensuing rabi food crop. The soil moisture levels in most parts of the country are conducive for a record rabi output in the coming season unless there are further weather vagaries. Also, water levels in most of the reservoirs have reached high levels and will support not only the rabi crop but also act as a cushion against irregular rainfall in the next few seasons," says Acuité Ratings & Research.
Although floods have adversely impacted the second quarter, benefits of PM Kisan and good soil moisture will ensure good Rabi crop and pickup in rural demand in the coming quarters. A positive Monsoon effect will help turn around the broad-based slowdown in rural demand, which has been one of the key headwinds from the past few quarters. Once rural demand and incomes improve, this will boost the corporate earnings of rural focussed businesses in India and thus provide another opportunity for Sensex and Nifty to advance further.
Trigger 3 - Labour reform
Labour regulations have eased a bit over the past few years but the plan to merge multiple labour laws into four codes is a major reform. The impact of labour reforms would be felt more in the macro-economy and broader markets over the medium term. Indirect marginal beneficiaries include the financial services sector given the wide Social Security coverage that is envisaged. We also think a universally administered universal minimum wage could boost consumption at the margin.
Reforms help sustain the positive reform narrative. Labour reforms are key element of the government's reform narrative, especially for global investors, given the backdrop of India's golden opportunity to benefit from a manufacturing shift away from China.
Current labour laws are a drag on productivity and competitiveness. India's labour regulations are perceived to be rigid with multiple laws at the national level. In various states, labour laws are a concurrent subject. Existing labour laws encourage a low scale of manufacturing as many laws apply only when businesses have a certain number of workers, thus dragging down productivity. As per the Annual Survey of Industries (ASI), an overwhelming 72% of the firms in India have between 0-49 employees, although the output (or net-value add [NVA]) share of such firms is just 6.9%. The average size of Indian manufacturing firms is far below global peers.
“We believe it could reduce compliance costs, making it easier to do business; remove disincentives for small businesses to scale up (a structural issue in India), and encourage formalization. We think these reforms could help support the government’s reform narrative and would improve long-term growth outlook, boosting multiples," Gautam Chhaochharia, Analyst, UBS Securities India Pvt. Ltd said.
The Code on Wages consolidates four existing laws and universalises the provision of minimum wages. The rigidity of laws regarding downsizing labour and cumbersome compliance is often cited as the main reason limiting scalability. The Code on Industrial Relations would raise the threshold required for government permission for layoffs/terminations from 100 to 300 employees, and tighten regulations for trade unions. However, this is still a draft. The Code on Wages covers employees in the organized and unorganized sectors. The draft Code on Social Security would include 500 million people under provident fund/retirement benefits (10x the current number). This is in line with the government's recent reforms to extend pensions to the unorganized sector and small and medium enterprises (SMEs).
UBS analysis suggests prevailing on-the-ground wages in the organised sector are in line with or above the minimum wages recommended by an expert committee under the new code. But we think there is still potential for a “lighthouse effect” in which minimum wages set a benchmark that pulls up wages, especially in the unorganised sector, though the extent is unclear, said Dipojjal Saha, Strategist, UBS Securities India Pvt. Ltd.