SURPRISE of intense and sustained fall
In the middle of 2018, economic indicators were turning positive, capacity utilization had picked up in various sectors and there was hope that private investment is coming back. After that, certain things happened one after the other sequentially. Market and economy would have withstood two or three of these, but a confluence has caused an intense downward spiral.
The first one is a long standing issue of clean up of the financial sector exacerbated by bad loans in the NBFC sector. The second was usual pre election uncertainty (May 2019) where investors hold back. The third was the unconventional budget (July 2019) with long term good strategy but not having quick short term measures to boost the market. Fourth was an unintended consequence in the Budget of raising income tax on Foreign Portfolio Investors , since these are trusts and treated as individual taxpayers( they sold USD 2 billion of Indian equities in July 2019) . Fifth is Federal Reserve cutting interest rates but characterizing it just as a small mid cycle adjustment and not as a precursor to major liquidity boost.
Sixth is the important sector of automobiles going down because of less credit and also structural but short term reasons where people are deferring purchases because of new Bharat 6 emission standards and government moving towards its electric car policy with alacrity. Seventh is new Andhra Pradesh state government’s decision to review infrastructure and power projects initiated by the previous government (that can jeopardize foreign portfolio inflows and renewable energy production targets). Last is the psychological or technical factor where selling leads to more selling with our extrapolative minds and important levels break one after the other.
URGENT measures forced by markets
The budget as discussed previously is good in long term with an objective to achieve a 5 trillion USD economy by 2024 but lacked short term boosts or steroidal treatment. However, this sharp fall has focussed attention and will force the government to move fast on various dimensions. Budget had lots of policy statements and now their enactment will be urgent
First is to decrease the cost of capital. In the previous similar situations in early 2000s, growth was fuelled because of the cost of capital coming down. Budget by being fiscally prudent and intending to borrow more abroad provided the confidence that there will be no savings squeeze-it led to bond yields going down, presently trading at 6.33%. RBI is also expected to maintain its accommodative policy and will cut interest rates further. Government is also injecting more liquidity in the system by recapitalizing banks. This will lower the cost of borrowing for the corporates. A new contingency framework as spelt by RBI will be good for NBFC without enhancing moral hazard.
Second measure is to expedite infrastructure spending. Budget provided a target of Rs 100 lakh crore over a five year period which is a very significant number. Implementation will be the key to getting the confidence back in the economy.
Labour reforms have to be implemented fast. Two labour codes are already there and the third one deals with industrial relations and has some significant changes in terms of limits and overtimes.
Fourth step is to increase the pace of asset monetisation, disinvestment and privatisation. Another factor, according to Mr Rajiv Kumar, Vice Chairman Niti Aayog is an ongoing serious attempt to improve the government’s capital output ratio.
BENEFITS of resilience
With the implementation of above steps, the growth should start picking up by 4th quarter of the current financial year. In the first term there were measures like IBC, RERA, and Benami Act & GST. These led to formalization of the economy and different economic agents have to adjust. There is in a way cleansing accompanied by some creative destruction. It also means that new growth will be far more sustainable and faster than the previous boom and bust cycles.
Additionally, many stocks have been oversold and fallen below their book value thus presenting very good buying opportunities. My recommendation will be to retain the existing positions and we should be able to catch a powerful and sustained up move eventually. Giving a cricket analogy, we might have a lost a couple of early wickets, the need of the hour is to bat deep to win the match.
As always, the lowest point is impossible to determine and we allocate only long term money to equities since fluctuations and volatility, sometimes more painful as in the current environment, can always surface.