Structural measures to start showing results shortly

Amid all the news, views and counter views around ‘acchey din’, it’s a fact that BJP government has initiated some strong structural measures to improve Indian economy since coming to power in 2014. Power sector reforms, railway infrastructure up-gradation, urban infrastructure up-gradation, defense production are all very strong measure and will surely usher in brighter economy going forward. If one tries to see the infrastructure capex involved in one of these measures the Government of India has announced five big urban development plans: The cleanliness drive (SWACHH Bharat Abhiyan) is expected to cost over Rs62000 crore (US$9.1 billion) till 2019. Providing housing to all (by 2022) will see investment of around Rs 2,14,286 crore per annum for construction of 20 million houses during FY16-FY22. The direct impact is estimated to be 1.52 per cent and indirect impact 1.98 per cent on India’s GDP. Upgrading the heritage cities (HRIDAY) will see total outlay of Rs500 crore over next 12 months.  Improvement in sewerage networks and water supply management across 500 cities (AMRUT) will see further about Rs1 lakh crore (US$15 billion).Investment on urban development under Smart Cities Mission (US$ 7.1 billion) and the Atal Mission for Rejuvenation and Urban Transformation (US$7.4 billion) of 500 cities has already been approved by the government.

 

But these measures are structural in nature and will require some time before we start seeing impact of these at ground level. Natures of these ambitious plans are such that implementation will require strong co-ordination between central government, state government and local bodies. And we have rightly witnessed strong fiscal federalism taking place in India in this regard. But to get the mechanism of such co-ordination has to take some time. Though, we are of opinion that we should start seeing impact on economy from next fiscal onward.

 

In fact we were very disappointed post budget last year as FM had ignored the need of front loading some purely central government driven infra capex so that economic climate in India should have remained buoyant till benefit of long term structural measure would have started bearing fruits. But FM thought differently then and paid the price of getting country disillusioned with ‘achhey din’ theme. But in present cyclical disillusionment phase many economist were recommending aggressive public spending disregarding fiscal deficit target which could have been highly counterproductive as long term measures already initiated by the government will shortly start showing results.  Added pressure on fiscal deficit was 7th pay commission and OROP. Though, 7th pay commission and OROP is also an indirect consumption stimulus for Indian economy to the tune of Rs 4.5 tn over next two years. But thankfully FM has remained discipline in this budget and has remained firm on fiscal deficit target.  That’s the biggest takeaway of the budget this time. This budget also paves way for RBI to again go soft on interest rate.

For past over six months Indian equity market has consistently seen selling by FIIs. It is largely on account of selling by Sovereign Wealth Fund. The Sovereign Wealth Fund Institute, a Las Vegas-based firm that tracks activity by funds, estimates that $3.043 trillion was allocated to listed equity as of December 2015, down around $213 billion from December 2014.

The SWFI estimated that another $404.3 billion could be withdrawn from global listed equities in 2016 if oil prices remain between $30 and $40 a barrel.

Earlier oil producers exported capital through SWFs. But their combined current account at current oil price swings by US$0.5 tn to a deficit of US$100 bn. And this is causing this reversal of flows and is likely explanation of redemption-type selling seen lately. Unfortunately as of now beneficiaries of lower oil prices do not have mechanisms yet to deploy their surpluses.

 

Sovereign-wealth funds have grown significantly over the past two decades, growing to more than $7 trillion in assets from less than $1 trillion before June 2001. Some of the largest SWFs of the world like Norway’s Global Pension Fund, United Arab Emirates’ Abu Dhabi Investment Authority, Singapore’s Government of Singapore Investment Corporation, China’s China Investment Corporation, Saudi Arabia’s SAMA Foreign Holdings and Kuwait’s Kuwait Investment Authority has grown due to high oil prices, booming investment returns, excess current account surpluses and easy monetary policy around the globe.

The total investment of SWFs in Indian equity is pegged at Rs 1.75 trillion as on December 2015. In 2012, total equity investments of SWFs were only Rs 55,438 crore. And surely some part of this money is getting redeemed as part of global withdrawal.

Incidentally, the share of pension funds – another category with large pools of money in terms of FII investment in India– has also fallen from 8.05 per cent to 5.98 per cent between December 2014 and 2015 due to fear of rate rise in US.

So, what remain trackables now? 1. Trend of revision in Nifty and Sensex earnings and 2. Global liquidity environment and 3. Some risk of government becoming populist and losing momentum on key initiatives already undertaken

Single digit growth in government deficit unfortunately in short term could result in earnings growth falling below 10% in FY17. EBITDA growth of BSE 500 corporate would have been 12%+for FY17 if fiscal loosening had happened compared to the 5%-6% growth expectation for FY16 (1HFY16: 4%). Absence of fiscal loosening may cause EBITDA growth rates to be in single digit for FY17 too. Although still an improvement over the 3.5% growth witnessed in FY15, it is significantly below the growth numbers of 17%-22% achieved between FY10-FY12 and the median growth of 17.5% over FY01-FY15. Given the sluggish growth expectations, our base case now assumes further delay in earnings recovery.

Now to price assumption- We are factoring Sensex EPS growth of 9% in FY17 (lower than street double digit assumption) and that implies our Fair value estimate of SENSEX at 24564. So, market is slightly under valued right now and provides decent return possibility going forward. However the question is, whether in an ongoing bull market, should market ever trade below fair value?

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