The first six months of the new government have been very eventful. We’ve seen a lot of new initiatives being undertaken to revive the economy. Several new policy measures like ‘Make in India’, ‘Swachh Bharat Abhiyan’ will go a long way in making India more competitive and productive. Simultaneously, there are clear signs that consumer demand is bouncing back. Recent automobile sales figures offer an early indication of that. The prevailing positive sentiment will translate into actual sales growth and improved profitability for corporate India in the next few quarters.
On The Road To Reforms
The most far reaching measure taken by the government has been complete deregulation in automobile fuels. Oil marketing companies such as Indian Oil Corporation (IOC) are now free to determine diesel prices. Petrol prices are already decontrolled. With this measure, diesel prices will be aligned to global prices on a quarterly basis. Fuel under-recovery for FY14 is now expected at Rs 90,000 crore versus Rs 138,000 crore last year. This will ease off the fiscal deficit situation and provide a big relief to oil marketing companies.
The electronic auction of coal mines will create an environment for a transparent process for allocation of natural resources. Last few years saw several controversies around non-transparent and adhoc policies to allocate scarce natural resources. These processes are now being streamlined to ensure that there is no misappropriation of national wealth.
The government plans to ease the norms for starting and shutting down new businesses. This will boost entrepreneurial activity in India. India is a land of millions of small and medium scale entrepreneurs and improvement in business sentiment will lead to rapid growth in this segment.
Revival of large stalled projects will give a boost to capital formation activity and restart the investment cycle. We expect that the new government will identify some large infrastructure projects and concerted push will be given to drive them to completion. Environmental clearances, a big road-block for large projects has been IT enabled thereby cutting lead times and expediting infrastructure creation.
There are a number of measures that we expect the new government to take in the next few months- Goods and Services Tax, direct cash transfer of subsidies and the passage of insurance Bill.
Come, Make in India
In his Independence Day address, PM Narendra Modi talked about making India a manufacturing hub. He invited manufacturers to ‘come make in India’. India can become a big export hub by manufacturing auto components, agricultural products, leather products, textiles, gems and jewellery and machinery products. PM also wanted to ‘channelize the strength of the youth through manufacturing’, considering a large number of youth can be employed in these proposed manufacturing hubs. He stressed on manufactured goods having zero defect and zero effect on environment.
It is a very ambitious vision. However, considering the track record of the Prime Minister in Gujarat, it seems very much doable. Previous governments have had ambitious targets of increasing the share of manufacturing in India GDP to 25% from the current 15% level. However, due to lack of execution, this vision has remained a pipe dream. This can change with a focused policy approach and determined execution. Focus on manufacturing sector would help in creating employment besides helping curb the current account deficit.
The recent rupee depreciation can make Indian manufacturing competitive globally. With clever resource allocation, India can become a global manufacturing hub in sectors like automobiles & auto components, pharmaceutical, textiles, gems and jewellery, leather goods, IT hardware and solar power. The special economic zones (SEZ) policy was launched with this very intention. However, policy muddles and land acquisition issues brought this to a complete halt. SEZ policy will need to be revived and several incentives will need to be given to the industry to expand in these sectors.
Labour laws also need a complete overhaul so that producers are encouraged to hire more employees. Once Labour and land issues are streamlined and cheap finance is available to industry, Indian manufacturing will blossom and will lay the foundation of a virtuos cycle of productivity gains, high salaries and high growth.
Swachh Bharat Abhiyan
The Clean India campaign is a national level campaign by the Government of India covering 4041 statutory towns to clean the streets, roads and infrastructure of the country. Prime Minister’s focus on cleanliness can lead to several long term gains like better health, less diseases and improved productivity of the labor classes. This campaign aims to accomplish the vision of ‘Clean India’ by 2 October 2019, 150th birthday of Mahatma Gandhi and is expected to cost over Rs 62000 crore (US$10 billion).
GDP Growth Rebounds
India’s vicious economic cycle between 2010-2013 of slowing growth, elevated twin deficits and a skewed savings profile is coming to an end. GDP growth for Q1 FY15 came in at 5.7% surpassing consensus expectations.
Growth had stagnated at 4.5-5% for last ten quarters pulled down by poor performance industrial sectors. The strong rebound has been led by manufacturing and export sectors. Investment activity is expected to revive soon. With people being more confident about their future economic prospects, consumers have begun to spend again.
We would expect a GDP growth of 6% in FY15 and believe that economy will see a revival of growth and earnings cycle. Cement and four –wheeler sales numbers have also been on the uptrend. We believe a macro-economic revival is on the anvil. Activity in the eight core sectors — coal, crude oil, natural gas, petroleum refinery products, fertilizers, steel, cement and electricity – which are considered as vital cog in economic growth should rebound due to increased industrial activity and better GDP growth numbers in the next few quarters.
Commodity Price Correction
Declining oil, gold and coal prices should result in multi-layered benefits for the Indian economy, its external accounts, capital markets and savings profile. Brent Crude has corrected 30% YTD resulting in significant reduction in India’s fuel subsidies.
Fears of a supply glut have lead to a sharp decline in crude oil prices in the last few months. US production has hit the highest levels since 1987 which has pressured WTI prices. Libyan production is being ramped up post stabilizing of internal situation. Both the EIA and IEA reports indicate a very comfortable supply picture while trimming their demand forecasts for this year. Economic data from the eurozone is dismal while Chinese data is also raising concerns about demand growth.
Fuel under-recovery in India is now expected at 80,000 crore for this fiscal versus 138,000 crores last year. This will help the fiscal situation and Fiscal deficit target of 4.1% is likely to be achieved.
Gold price correction helps India’s external account. Last year India saw a run on its currency due to rapidly galloping current account deficit. That was largely driven by gold and crude oil imports. With a significant reduction in gold prices, India’s current account situation is getting a lot comfortable.
We believe that for this fiscal current account deficit will be capped at 2% of GDP giving currency the much needed stability.
With gold and property prices remaining subdued, we expect that financial savings will make a comeback with a large percentage of savings being redirected to financial assets like equity and fixed income. This will help revive India’s GDP growth.
Despite the inflation data getting comfortable, RBI has decided to hold rates at current levels. Both CPI and WPI inflation rates have cooled off significantly in the last few months. CPI inflation is now down to 5.5%, almost half of the levels prevalent last year. Governor believes and we agree that it is important to break the back of inflation to ensure a sustainable growth trajectory. The emphasis on core CPI as an inflation metric as compared to WPI is expected to continue. We expect CPI to average around 7% level for next few months thus ruling out any monetary easing this calendar year. We expect interest rates to cool-off by 50-100 bps in next calendar year.
Interest rate cuts would be beneficial to interest rate sensitive sectors like banking, automobiles and infrastructure.
Continued recovery in US is a significant positive for Indian equity markets. Easy monetary policies globally remain a supporting factor for equity investments. US economy is expected to grow at 3% during the third quarter due to strong consumer spending. European central bank has carried out a fresh monetary stimulus which will help stabilize European economy. Slowdown in Chinese growth will lead to downward pressure in commodity prices. This is beneficial for India, a net commodity importer. The revival in global risk appetite has resulted in FII inflows into emerging market equities with India turning out to be a big beneficiary. India has been one of the top performing equity markets this year with fresh equity inflows of 14 billion dollars.
From an equity market stand-point, macro-economic revival in India will open opportunities to make strong returns in the next few years. We would expect a GDP growth of 6% in FY15 and believe that economy will see a revival of growth and earnings cycle. The agricultural and services sector continue to show strong traction and gradually even manufacturing sector should pick-up as consumer demand revives. A real GDP growth of 6% along with Inflation of around 7% should lead to a nominal GDP growth of 13%. Sensex earnings growth has improved from 5% in FY13 to about 10% in FY14 on the back of rupee depreciation. For FY15, we would expect a Sensex EPS growth of around 15%.
We would believe that earnings growth for five to six year business cycle should be atleast 20% considering the economy will revive from a very low base. If the infrastructure cycle revives quickly, the earnings growth revival will be faster with even 25% CAGR looking possible. A multiple rerating is also possible as cost of equity goes down in the next few years with the decrease in risk free rate. An earnings growth between 20-25% and multiple rerating from 15x to 16-17x in the next few years can lead to a 25% compounding of Sensex returns, which will take it to 100,000 levels by Calendar year 2020! Looking at the current macro trends, cooling commodity prices, governance reforms and revival in growth, we are extremely confident that our Target of 100,000 by 2020 is easily achievable.
Truly, Achhe Din are around the corner!