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The full majority gives BJP led NDA government a significant political capital. It also reinforces the belief in some ofthe policies undertaken during their last term; particularly the actions to keep the inflation contained and focus onsocial security net. The measures to improve rural roads and electrification, build rural houses, distribute free LPG,free LED, free toilet and expansion of social security net in terms of pension and medical insurance had earned thema significant political mileage. The prime-minister’s speech has been harping on shift from ‘caste’ to ‘class’ politics;the class of “have(s) and have not(s). Have(s) must support have-not(s). In India, North and South divide is stark.North Indian states, accounting for nearly two thirds of population earn a per-capita Income which is half of thesouthern population. They need to converge in their standard of living. And in our view, the focus on welfareschemes will continue in the second term of the government. The welfare aspects may expand to other key aspectsof life such as providing ‘safe drinking water’. At the same time, the government should focus on effectiveimplementation of the existing schemes as well and iron out the wrinkles in their execution.
As the government commenced its second term, the Cabinet has approved the plan to extend the PM-KISANscheme, including all eligible farmer families irrespective of the size of land holdings with an estimated centralgovernment expenditure of Rs. 872 billion for FY20 (Rs122 billion higher than FY2020BE). It also announced apension scheme for shopkeepers, retail traders and self-employed persons assuring a minimum monthly pension ofRs 3,000 after 60 years of age. It has also announced a pension scheme for farmers.
Even as the government undertook social expenditure, it did not fray from the path of fiscal consolidation at large.We expect the broad fiscal prudence to continue even in the second term. Barring the natural course of inflationmean reversion, the inflation scenario should broadly remain well behaved.
The government is likely to display continuity on the broader economic reform agenda. During its first term reformsseen were in the area of FDI liberalization, implementation of GST, Insolvency and Bankruptcy Code, financialinclusion, regulation in the real estate market, and setting up of monetary policy committee. The policies were alsoaimed at spurring infrastructure activities and easing the conditions for doing business in India.
Yet, challenges in front of the government are bigger as compared to 2014. Growth has been softening. The latestGDP print of 5.8% for Q4 FY19 is at five year low. A part of it can be due to election related factors (slowdown ingovernment infrastructure related orders ahead of election, postponement of business capital spending plans). Asthe election is over, some of these shelved spending should come back. But even after accounting for it, analysis ofthe underlying data point to a severe slowdown in growth momentum. The issue on unemployment has beenofficially acknowledged (NSSO estimates put unemployment rate at 6.1% for 2017-18). Inflation is within theirrespective target bands and is a non-issue while the external outlook is mired with uncertainty.
Policy support is needed. The final central budget is to be placed in parliament on 5th of July. As of now, owing toweak revenue buoyancy, fiscal is relatively hand tied, unless of course the finance ministry is ready to accommodatesome slippage or the Jalan committee comes out with some material bonanza from RBI in June. Still, favorableelection outcomes should help the government to undertake some of the unfinished tasks such as enforcing the GSTcompliance and bringing about the tax buoyancy. There have been serious liquidity issues in the financial sectorsince the middle of last year. Non-banking financial entities (NBFEs) will continue to keep markets on the edge asthere are huge re-financing risks. Reviving the real estate sector should also be focused on. With a reform friendlygovernment at helm, confidence among business community and investors should return.
Some reforms have lent disruption to the economy as reflected in slowing growth momentum. Government wouldhave to focus on a host of other reforms that offset disruption, helping the economy making a smooth transition.For instance, sharp fall in inflation is positive for the economy but lower food prices have created distress amongfarmers. Reforms are needed to ensure better income growth for farmers. Next generation financial sector reformsshould also be on the table to attract both foreign and domestic savings to meet huge investment needs. Legislativereforms and a mind-set change were the major agenda for the previous term. Execution should be the key now.
In 2014, Modi government launched its flagship campaign, called ‘Make in India’, targeting domestic manufacturing.The progress under this initiative has not shown up yet (the manufacturing share has not improved). The tradetussle between US-China has led to an increased spotlight on the shift of manufacturing away from China. China'sannual manufacturing exports sums to US$2.5 trillion, which is more than India’s total GDP. India can benefit fromthis evolving global condition. The country has improved over the past three to four years on many factors such asease of doing business reforms, financial penetration, and improved infrastructure. The policy makers should nowfocus on the sectors on which the US has imposed tariffs on China, on sectors where China is trying to limitproduction due to domestic reasons and where India already has an established manufacturing base. There are acouple of sectors like electrical/electronic products, clothing, footwear, chemicals and industrials that can showsignificant positive delta in exports with some policy nudge. A greater focus on innovation and technology is critical.
While effects of fiscal measures will take time to trickle in, RBI will be expected to take lead in supporting growth.We expect both rate cut (at least 25bps in June) and liquidity support (liquidity to turn neutral in a month’s time).Ideally, central bank should also change their stance to accommodative and explicitly state to support liquidity intheir forward guidance. Guidance is monetary policy removes uncertainty and is as important as the actual action.
Indian equity market continued to move up for the third consecutive month in May and has risen 9.8% YTD. WhileFIIs have invested US$ 10.6 billion YTD, Domestic institutional investors turned positive on equities in May (US$ 750million) after two months of selling. A stable government is positive for the market especially as it could pushthrough pro-growth policies with greater ease. For the foreign investors, India also provides an added advantage ofbeing a natural hedge against the adverse growth impact of US- China trade dispute.
Coming to the earnings, last five years saw corporate earnings growing at a sub-optimal rate, given the backdrop ofstructural and disruptive macro reforms. India’s corporate profit to GDP ratio has moderated from 5.7% in FY10 to2.8% in FY19 and likely to be sub 2% in FY18. However, now the corporate earnings cycle appears to be bottomingout. With a revival in asset quality of corporate banks and likelihood of pro-growth policies by the government, FY20is expected to witness earnings growth over 20%. However, there is a limited room for any re-rating for the markets,given the current valuations (NIFTY 12m fwd PE at 19.5x). As we look towards easing of interest rate conditions, theinterest sensitive sectors should see gains. We are biased towards domestic cyclicals.
We had turned positive on Indian bond market since March 2019. As fundamentals and valuation looked positive,we believed it could create new demand (from sources such as FIIs) once the election overhang was over. This hasplayed out particularly sharply post the ‘market favored’ outcome in 2019 general election. G-sec has rallied by30bps in May, while SDL and Corporate Bonds have rallied by 56 bps and 43bps respectively since March. Thecontinuity of government has alleviated the concerns of sharp fiscal slippage and hence higher G-sec supply. Thatsaid, fundamentally a weak tax collection for the central government continues to be a concern and that still keepsthe risk of 10-20bps fiscal slippage in FY20 alive. Upcoming budget announcement will be closely watched. As suchwe still remain concerned on fiscal and consequently, the overall sovereign and quasi-sovereign bond supply forFY20. Some risks also remain from the uncertainty around oil prices.
Despite the fiscal and oil risks, we continue to be positive on fixed income duration. While the valuationattractiveness has partly materialized, the spreads are still higher than long-term trends and can further narrow,particularly when we expect easing monetary conditions in India. We expect additional 50bps rate cut in 2019 andliquidity to turn to neutral/ surplus by June end. Credit spreads have widened significantly and risk-reward looksfavorable in that space.