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The Indian stock market (Nifty) crumbled Friday on the concern of a terrible GDP and subdued global/HK cues amid lingering suspense over China’s stance on Trump’s Hong Kong legislation approval despite U.S.-China Phase One trade deal said to be only ‘millimeters away’. The market was apprehending India’s Q2 GDP may come lower below 5% and various estimates were ranging between +4.7% to +4.2% and eventually, it came around the mid-point of +4.5% in line with market estimates.
On early Monday Nifty inched up on telecom optimism after a ‘substantial’ price hike by India’s 3-main private operators (Reliance Jio, Bharti Airtel and Vodafone Idea). The market was also supported by hopes & hypes of further monetary stimulus (RBI cut) as-well-as fiscal stimulus (personal tax cut by the government in Feb budget). Nifty was also buoyed by upbeat manufacturing (Mfg) PMI in Nov at 51.2 from prior 50.6, higher than the expectations of 49.8; back in the expansion zone and also bounced back from the 2-years low. But still subdued Nov auto sales with no signs of recovery also undercut the market sentiment.
Markit said production growth strengthens in November, but remains subdued. Rise in output among weakest in one-and-a-half years, and employment falls for first time since March 2018, while there is modest upturn in sales. Markit also said, although the Indian manufacturing has rebounded to some extent in Nov due to increased export, it’s still far away from its earlier growth scaled early 2019 as domestic demand is still soft:
Although business conditions in the Indian manufacturing sector improved in November, the upturn remained subdued compared to earlier in the year and the survey history. Growth rates for new orders and production were modest, despite accelerating from October's recent lows, while firms shed jobs for the first time in 20 months and continued to reduce input buying. At the same time, there were only slight increases in input costs and output prices halfway through the third quarter of fiscal year 2019/20. The headline seasonally adjusted IHS Markit India Manufacturing PM rose from 50.6 in October, when it had fallen to a two-year low, to 51.2 in November. The latest reading was below the survey average (53.8) and indicated only a slight improvement in the health of the sector.
Consumer goods provided the main impetus to overall growth, while the intermediate goods category returned to expansion territory. Conversely, there was a solid deterioration in operating conditions at capital goods makers. Indian manufacturing production increased only moderately in November, albeit at a quicker rate than October's two-year low. Anecdotal evidence suggested that growth was supported by the launch of new products and better demand, though restrained by competitive pressures and unstable market conditions.
Total sales increased for the twenty-fifth month in a row, with growth strengthening from October's recent low. That said, the upturn was among the weakest over this sequence. Some firms were able to secure new work amid successful marketing and strengthening demand, but others struggled in the face of competitive conditions, a challenging economic scenario and troubles in the automotive sector. Manufacturers were partly helped by external markets, as signalled by a further expansion in international sales. The increase in exports was slight, however, and among the weakest over the past year-and-a-half. Subdued sales prevented hiring in November, with payroll numbers declining for the first time in 20 months.
A number of companies indicated that workloads had been managed by existing staff, while others cited the non-replacement of retirees and non-renewal of temporary contracts. Firms also scaled back input purchasing, with the latest decline the fourth in as many months. Subsequently, the current sequence of falling stocks of purchases that started in August was extended to November. Rates of contraction for both input buying and inventories were marginal.
Holdings of manufactured goods likewise declined, with the pace of depletion being solid in spite of softening from October. Business sentiment strengthened in November, with panel members expecting advertising efforts and product diversification to support output growth in the year ahead. That said, the Future Output Index was well below its average, as a number of firms were concerned about the state of the economy. Finally, there were only marginal increases in both input costs and output charges in November.
Commenting on the latest survey results, IHS Markit, said:
After pulling back noticeably in October, manufacturing sector growth displayed a welcoming acceleration in November. Still, rates of expansion in factory orders, production and exports remained far away from those recorded at the start of 2019, with subdued underlying demand largely blamed for this. Some level of uncertainty regarding the economy was evident by a subdued degree of business optimism.
Also, companies shed jobs for the first time in over a year-and a-half and there was another round of reduction in input buying. The weakness of these forward-looking indicators suggests that firms are bracing themselves for challenging times ahead. PMI data continued to show a lack of inflationary pressures in the sector which, combined with slow economic growth, suggests that the RBI will likely extend its accommodative policy stance and further reduce the benchmark interest rate during December.
On Friday, after the Indian market hours, the government data shows that the Indian GDP growth slumped to +4.5% in Q2 from +5.0% in Q1 (FY20), lower than the market expectations of +4.7% and grew at a 6-years low after 5th consecutive quarterly slowdown (on y/y basis). The GDP grew by only +0.4% in Q2 from Q1FY20 sequentially. Also, another data shows that the Indian core sector (infrastructure) output contracted -5.8% in Oct from the prior contraction of -5.2% in Sep.
As a pointer, the Indian GDP growth was at +7% in Q2FY19 and +8% in Q1FY19 (a year ago), which essentially means that the economy is now growing almost at the half rate than a year ago. Moreover, several leading indicators (like Air traffic, rail freight, power consumption, auto sales) in recent months are showing that the Indian economy may be now growing at even slower rate around 4% due to subdued consumer spending, manufacturing activities, muted private capex (business investment) and slowing exports to some extent. In that sense, the Indian economy is now a victim of its own structural deficiencies along with synchronized global slowdown due to lingering Trump trade war uncertainty.
Details of India’s Q2FY20 GDP:
GDP AT CONSTANT PRICES GROWTH WEIGHTAGE
Contributions in percentile to the GDP growth:
Projected GDP growth in Q3 and Q4 as per present quarterly run rate:
Although the official calculation methodology of the Indian GDP has some element of controversies, in Q2, as per the government data, a line item ‘discrepancies’ dragged the GDP by -2%, while net trade helped by +1.7% (as imports slowed more than exports); PCE (Private Consumption Expenditure-private spending) contributed +2.7% followed by GCE (Government Consumption Expenditure-government spending), but GCF (Gross Fixed Capital-private capex) slips. The line item ‘discrepancies” may be unorganized sector output (?).
In Q2FY20, the GVA (Gross Value Added- GDP excluding taxes) grew +4.3%, below +4.9% in Q1FY20 and +6.9% in Q2FY19 (previous year). Manufacturing contracted -1% in Q2, after rising a meager +0.6% in Q1. Slight slowdown was also seen for financial, real estate and professional services in Q2 (+5.8% vs +5.9% in Q1); trade, hotel, transport, communication and services related to broadcasting (+4.8% vs 7.1%); construction (+3.3% vs +5.7%); utilities (+3.6 vs +8.6%); and mining (+0.1% vs 2.7%). On the other hand, acceleration was seen for public administration, defense and other services-PADO (+11.6% vs 8.5%) and a slight improvement in agriculture, forestry and fishing (+2.1% vs 2%).
In brief, except for government spending (largely in defense) and agriculture to some extent, there was a widespread slowdown in almost every other sector in Q2FY20. As per the present run rate, the Indian GDP may grow +4.6% in Q3FY20 and below 4% in Q4FY20 (under normal conditions). But assuming the lagged effect of various fiscal and monetary stimuli for the last few months, the Q4FY20 GDP may grow around +4.4% (y/y).
The most worrying factor is nominal GDP (at current prices) grew at +6.1% in Q2FY20 vs +8.0% in Q1FY20 and +12.0% in Q2FY19 (last year). In simple word, the nominal GDP growth is like operating profit of a company (EBITDA), which tumbled almost 50% in Q2FY20, This is largely due to a slump in manufacturing (-1.1% vs +2.0% and +11.6%) and mining & quarrying (-4.4% vs +5.5% and +21.9%). Also, the other sectors except PADO witnessed a significant slump when compared to last year's growth in Q2FY19.
Overall, there was a widespread slowdown in almost every sector of the Indian economy in H1FY20. The present trend in weak revenue (tax) collection and lower GDP growth (both much below government’s budget estimate) coupled with increasing government expenditure (spending-fiscal stimulus) is indicating that India’s fiscal deficit could hit around -4% in FY20, much higher than the government estimate of +3.3% and market expectations of -3.6%. The nominal fiscal deficit may come around -Rs.8T by Q4FY20. And if we consider unpaid food and subsidy bill (FCI/PFC) the consolidated actual fiscal deficit (Federal + state governments) may come much higher at around -9% from present levels of -6.5%, which may affect India’s credit rating and outlook.
As a pointer, Indian PSUs (Central/Federal and State/Provincial governments) are traditionally the largest safe job providers in the country and almost 40% of government revenue goes into meeting the huge salary/pension bill. This combines with interest payment on debt by the government (almost 25% of revenue), around 65% of government revenue goes into these two accounts (salary and interest), leaving little for the required government capex/fiscal stimulus to bring out the economy from a deep slowdown.
But overall, despite the subdued economic activity, Nifty gained +1.50% in Nov and made a new lifetime high of 11158.80 as the market is expecting more monetary as-well-as fiscal stimulus from the RBI and the Modi government. The market is now expecting -0.40% rate cut by the RBI (India’s central bank) to bring repo rate to +4.75% from present +5.15%, the lowest after 2008 GFC (global financial crisis) to bring out the economy from the deepest slowdown since 2013.
On Friday (28th Nov), Nifty surged +0.42% after a report that government may take over real estate stressed assets (NPA) and may also unveil a huge infra stimulus package of Rs.100T over next 10-years to stimulate the economy, especially construction sector, providing significant job creations for the unorganized sector.
The market is also expecting the Indian PM Modi may fire another fiscal bazooka (stimulus) in the form of personal tax cut/recalibrations (reform); especially for the middle-class category to stimulate muted consumer spending and bring out the economy out of a deep slumber.
Apart from hopes & hypes of monetary/fiscal stimulus, the Indian market was also helped by telecom optimism as India’s 3-private telecom players (Reliance Jio, Bharti Airtel and Vodafone Idea) had announced their intention to hike telecom fees appropriately to make telecom business feasible and sustainable in the long term. Also, the Indian government announced some temporary relief measures to delay spectrum usage fees payable to the government by another two years (with late fees interest).
But there was no relief for the AGR payments as directed by the Hon’ble SC, bringing Vodafone to the brink of collapse in India along with severe stress for Bharti Airtel. In brief, the so-called telecom relief package by the government was largely ineffective.
In November the Indian market was also affected by the political circus in India’s financial capital Mumbai and an important state Maharashtra-MH (both financially and politically, where ruling BJP party (Modi-Shah) ultimately failed to take control of the state Assembly. The market is concerned about growing political populism (e.g. farm loan waivers) by various states ahead of Assembly elections and a possible review of major infrastructure projects in MH including the HS Bullet train by the new MH government (a ‘rainbow coalition’ by SS-NCP/INC of varied political ideologies, fought each other before the election), which may hurt India’s image and fiscal deficit further. Also, Modi/BJP’s approval rate (popularity) is affecting due to slowing economy and rising unemployment and this is also not good for India’s present state of ‘political stability’ at te Federal government level.
On the big picture, Nifty soared almost +9.01% in the last three months (Sep/Oct/Nov) primarily on corporate tax cut big fiscal bazooka as-well-as a slew of small stimulus coupled with various regulatory reforms, RBI rate cuts (lower borrowing costs) and subsequent surge in corporate bottom line (Nifty EPS). The government cuts the long-pending corporate tax soon after Q1FY20 GDP growth slips to +5.0% with unemployment level at the highest in the last 45-years and subsequent hue & cry in media against the ‘Modi government’. Eventually, Nifty jumped on PM Modi’s corporate tax cut fiscal bazooka worth around Rs.1.45T/pa.
This time also there is similar outcry in the media after Q2FY20 GDP growth further tumbled to +4.5%, at 6-years low, which may force the government to go for the much-awaited income tax cut (reform) fiscal stimulus for around Rs.1.75T despite limited fiscal space and the risk of fiscal deficit breach in a significant way.
The Indian government may launch a personal tax cut fiscal stimulus in Feb’20 budget to be effective from FY21 (April’21) to undertake demand-side fiscal stimulus, so that consumers will have some disposable income in hand to spend more. So far the Modi government undertook supply-side fiscal (corporate tax cut) along with some regulatory reforms for the ease of doing business. But those stimulus and deregulations were largely ineffective to stimulate demand as it failed to raise consumer income or more disposable money in the hand of the consumers. Also, the Indian NPA and shadow banking crisis are affecting consumer spending despite successive RBI rate cuts (monetary stimulus). Apart from still high borrowing costs, there is a lack of eligible and qualified borrowers amid rising corporate as-well-as retail defaults (NPA).
Although RBI cuts rates by -1.35% in the last 10/11 months to +5.15% at present, banks (lenders) have transmitted little to the real economy (borrowers) and there is a large disparity between RBI repo rate (+5.15%), India’s 10Y bond yield (+6.50%) and corporate bond yields (around 8-10%). In reality, actual borrowing costs for Indian business/corporates as-well-as personal loans have little changed in the last one year despite rare successive RBI rate cuts by the new governor Das as Indian bond yields are still at elevated levels.
Indian banks, especially private banks are very reluctant to cut rates because their overall cost of funds is still high. The Indian small savings rate is very high even currently around +8% and thus, banks are not in a position to lower their FD rates significantly as they will lose deposits. And banks can’t offer loans at rates below their FD rates. Again the high deposit rate of various small saving schemes are being sponsored (subsidized) and guaranteed by the government and it’s a legacy political issue to lower the same in a country like India, where social schemes (like free treatment, education, and unemployment benefit) are almost non-existent unlike in the DMs or even some EMs.
Indian ordinary households (middle class) tend to save more rather than discretionary spending because of the absence of any free social schemes, coupled with still relatively high savings rate and a sense of economic uncertainty, affecting consumer confidence. The Indian government is also a big-beneficiary of Indian savings because it’s one of the main sources of its fiscal deficit funding (through GSEC bond markets, where Indian PSBS-public sector banks are the largest customers).
Despite India’s high DEBT/GDP ratio, the country is relatively insulated from any significant external payment shock (FX volatility/vulnerability) as India’s large pool of domestic savings is basically financing the government debt, 90% of which is in local currency (INR) and owned by domestic institutions (DII-PSBs and LIC) though long end bond (10Y GSECS). But at the same time, the Indian bond yields are staying high because of the perpetual government borrowing amid consistent fiscal deficit breach, making overall borrowing costs for the real economy at elevated levels.
The Modi government earlier thought to tap the foreign bond market by issuing USD denominated sovereign markets to lower the yield on the domestic bond market. But it may not be a prudent step considering FX volatility (weaker INR) and feasibility issues.
Due to India’s lower sovereign rating (BAA2 with a negative outlook by Moody’s or BBB- with a stable outlook by S&P and Fitch), the spread could be around +1.50% higher than 10YUST coupled with another +3.5% for FX (INR) depreciation risk (approx); i.e. almost +5% effectively above UST yield. The present 10YUST yield is now around +1.75% and after adding around +5.00%, the yield on such 10Y Indian sovereign bond yield would be around +6.75% against present 10YGSEC bond yield of around +6.50%. Thus, considering no cost-benefit and overall exchange rate risk (FX volatility and INR is not a free/fully convertible currency), the Indian government may have now abandoned that idea. And the domestic bond yield may stay elevated in the coming days.
In brief, India is a high-cost economy with no price stability-higher borrowing costs, devalued currency, higher imported as-well-as domestic inflation (especially on food, education, housing/rent, and healthcare) and higher tax (GST/Personal tax-highest slab at above 43%). Thus, at the end of the day, a middle-class Indian consumer has little left for discretionary spending. The Indian economy is now in virtual stagflation (lower growth, higher inflation, and higher unemployment).
Traditionally, India’s domestic consumption story as-well-as private/business capex was basically dependent largely on ‘black’ (unaccounted) money. In 2008 GFC, the Indian economy was largely unaffected due to the strength of this hidden wealth (black/unaccounted/off-balance sheet money) and the bank’s NPA (corporate as-well-as personal) was in control.
But the 2016 DEMO has destroyed this domestic consumption and private capex story, although the government intention was quite right. The Indian economy was already transforming from unaccounted to accounted (black to white) even before the DEMO. But this transformation and rebuilding/redistribution of wealth are taking time and until then, the economic slowdown may continue. After DEMO, the hurriedly launched chaotic GST is also responsible for the present economic slowdown. The overall cost of compliance of doing business for a small business may be greater than the business feasibility, affecting the overall unorganized sector and economic activity.
Looking ahead, the government has to unveil further fiscal stimulus through GST and Personal tax reform to boost consumer spending:
Although the corporate tax cut is one of the boldest fiscal reforms in Indian history and long overdue, it’s very doubtful how it will stimulate the overall economy by boosting consumer spending. Indian corporates may use the higher profit for this tax cut to a higher payout for shareholders (higher dividend, buyback, and bonus shares) rather than higher (incremental) capex (for expansion) until there is a revival of demand and the need for capacity expansion. Companies could also go for debt reduction with this windfall tax gain.
The companies may not pass the tax cut benefits to their employees by higher wages. The present tax cuts are limited to corporates and not to individuals. Thus, Indian consumers may not get any direct benefits, although companies could reduce their product/service price to some extent for the tax benefit windfall gain. But, again that is very unlikely. So, unless and until Indian consumers get more disposable money in their hands, discretionary/consumer spending will not grow significantly. Thus, some cuts are also necessary for personal tax along with a thrust in employment.
GST simplification/further reform is necessary:
The market is also expecting that along with corporate tax reforms, there will be further reform in personal tax, especially a cut for middle class/earners and rationalization of GST rates. There was a huge pressure on the government to reduce GST on automobiles from 28% to 18% and also for some other sectors.
The Indian GST system is perhaps the most complicated among G20 countries, having a very complex return filing system, having multiple slabs/rates (0%, 0.25%, 3%, 5%, 12%, 18%, and 28%-sin tax). Automobiles, cements-the two critical components of the economy are in sin tax of 28% category along with many consumer goods affecting consumer demand. Moreover, petroleum products, alcoholic drinks, and electricity are not taxed under GST and instead taxed by individual states/provinces separately as per the old tax regime of much higher tax.
Additionally, there is a special rate of 0.25% on rough precious and semi-precious stones and 3% on gold. Further, there is a cess of 22% on top of 28% GST applies on a few items like aerated drinks, luxury cars, and tobacco products. In India, the total tax component (Federal and State) on petrol and diesel is now around 75%, one of the highest in the world (against 25% in the U.S.). This is a legacy problem in India as a petroleum tax is an easy revenue source for both State and Federal governments.
In brief, India is a high-cost economy for decades-higher taxes, higher borrowing costs, devalued currency (higher imported inflation) and rampant corruption. But the Modi government is now taking steps like DEMO (partially succeeded to remove corruption), reducing corporate taxes and borrowing costs (RBI cut of -1.35% so far with more cuts of -0.40% may come). But Indian bond yields are still high due to surging fiscal deficit and subsequent government borrowings.
And it now also seems that the government is not willing to simplify the GST system to its true meaning (one nation-one tax) by clubbing all the seven tax slabs into one, say 18% with the simplification of return filling. India now needs minimum Rs.1T/month in GST collection, but the current run rate is lower and the GST deficit is increasing day-by-day as the economy is also slowing down. Although in Nov, the GST collection was upbeat at around Rs.1.03T, the overall deficit may be still significant.
There was a great hope a few years ago that GST will add GDP growth by at least 1% alone, but that’s not the case as the overall cost of the GST system is too high for both consumers and businesses, especially MSMEs. Thus the need of the hour is true GST reform to a single rate for all products and services and simplification of the return filing system, not mere recalibration along with personal income tax reduction. But considering the limited fiscal space, both GST and personal income tax cut now looks very difficult for the government even after considering the deluge of disinvestments (PSUs) and another possible special RBI payout to the government.
Overall, Nifty surged in Nov on positive global cues amid hopes & hypes of U.S.-China tentative trade deal, government fiscal stimulus including telecoms reliefs and disinvestment optimism, which may help to balance surging fiscal deficit. But doubts remain about the fate of fiscal deficit which may remain elevated at around +3.8 to +4.0% amid lower GDP growth, lower revenue and higher government spending/capex (fiscal stimulus). Also, weak currency (INR) and elevated oil is not good for the overall Indian economy, which is mainly imported oriented, although now almost 50% of Nifty EPS is generating from exports (positive for higher USD).
But the Indian market also got the boost of an unexpected EPS recovery in Q2FY20, thanks to the corporate tax cut, although overall revenue and EBITDA growth was muted to negative. In any way, the Nifty EPS stands around 435 at Q2FY20, translating a PE of around 27.80 at Nifty levels of 12100, at the historical bubble zone.
The Indian market is now expecting around 450 EPS (Nifty) by FY20 from FY19 levels of 400 on corporate tax cut boost. Even if Nifty EPS jumped to 450 levels in FY20, assuming an average PE of 20, the fair value of Nifty maybe around 9000 and an elevated PE of 25 (Modi premium), the fair value maybe around 11250. Looking ahead, at 12000 levels of Nifty, the market is discounting an EPS of 600 by FY21 (at normalized PE of 20), which may be far stretched from present levels of 400 EPS as it’s assuming a CAGR of almost 50% by next 2 year; i.e. at around 24% CAGR, whereas the average CAGR of NIFTY EPS is now below 10% for the last few years.
The 25% projected EPS CAGR growth for the next two years for Nifty may be a challenge considering Indian economic slowdown, subdued consumer spending, shadow banking crisis, lack of adequate NPA resolution, higher imported inflation (raw material costs) and corporate governance issue. Thus a Nifty EPS of around 500 by FY21 may be quite reasonable (assuming 10% growth from projected 450 EPS by FY20) and thus applying a PE of 20-25, the projected fair value of Nifty should be around 10000-12500.
Now the focus would be whether the Modi government unleashes another huge fiscal stimulus by cutting personal income tax and GST rates in the forthcoming budget despite limited fiscal space. The market will now also focus on PMI data, auto sales for Nov and also RBI policy meet on 5th Dec. The government will go for the personal income tax cut if the fiscal deficit will stay around +3.5% in FY20/21, which is unlikely.
Under normal circumstances, RBI may cut by -0.15% on 5th Dec to +5.00% with a hawkish bias as India’s headline CPI jumped to +4.6% in Oct from prior +4.0% in Sep (y/y), thanks to surging food inflation, which has no sign of cooling down till date. Although India’s core Inflation dropped further to +3.47% in Oct from prior +4.02% in Sep, RBI now officially follows headline CPI (under new governor Das), unlike other major global central banks (global norms). As a pointer, India’s core CPI has dropped from +5.72% in Nov’18 to +3.47% in Oct’19 almost steadily, which may be another reflection of India’s slowing economy and subdued demand growth.
As Fed is not going to cut again in Dec, the RBI may also cut only by -0.15% this time (Dec) and wait for further Fed signal and trajectory of Indian economy, the transmission effect of its previous cut of -1.3% to the real economy, government’s fiscal stimulus (any cut in personal income tax), borrowing program (trajectory of Indian bond yields) before going for another rate cut of -0.25% in Q4FY20 (Feb policy meet). The RBI has to maintain the bond yield differential between UST and India/GSEC; otherwise, who is going to fund Modinomics?
And considering very poor rate cut transmissions by banks so far (-0.50% against -1.35% RBI cut), RBI may give stress on proper transmissions of previous rate cuts rather than significantly cutting by -0.40% again in Dec as it will be futile. Thus RBI may go for only -0.15% in Dec to act again in Feb if an economic activity does not get any boost. RBI is now basically almost out of weapons after successive 5-rate cuts for a cumulative -1.35% over the past 10/11 months.
Technically, whatever may be the narrative Nifty Future (Dec) has to sustain over 12225 for a further rally to 12275*/12360-12410*/12495 and further to 12575*/12695-12815*/12880 in the near term (under bullish case scenario).
On the flip side, sustaining below 12200-12120* Nifty Future (Dec) may fall to 12000/11950*-11870/11800* and further to 11700*/11650-11495*/11350 in the near term (under bear case scenario).
Technically, Bank Nifty Future (Dec) has to sustain over 32200 for a further rally to 32300/32650-32850/33050* and further to 33325/33600*-33950/34300* in the near term (under bullish case scenario).
On the flip side, sustaining below 32150-31750* Bank Nifty Future (Dec) may fall to 31400/31200-30950*/30650 and further to 30350*/30050-29850/29550* in the near term (under bear case scenario).
Technically, USDINR (spot) has to sustain over 71.25 for a further rally to 71.60/72.05*-72.40/72.65* and further to 72.95/73.65-74.00/74.50 in the near term (under bullish case scenario)
On the flip side, sustaining below 70.90, USDINR (spot) may fall to 70.50/70.15*-69.90/69.50 and further to 68.85*/68.00-67.35/66.90 in the near term (under bear case scenario).
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