Nifty Almost Flat on Negative Global Cues and the Concern of Policy Implementation

  • Market Overview

Nifty Almost Flat on Negative Global Cues and the Increasing Concern of Reform Policy Implementation

India’s benchmark stock index Nifty closed around 15163.30 Friday, almost flat, but it slips almost -100 points from the session high soon after European market opening and slips into deep red amid soft GDP data from the U.K., which contracted -7.8% in Q4-2020 (y/y) amid big COVID 2nd wave, lockdown 2.0 and slow pace of vaccinations. The U.K. economy contracted almost -9.9% in 2020. On early European Friday, Dow Future was also dragged by energy shares as oil slips on subdued demand forecast by OPEC.

As the actual herd immunity in Europe-as-well-as U.S. may develop only by mid-2022, the economic recovery may continue to be fragile. Employment on both sides of the Atlantic may reach pre-COVID levels only after mid-2022 (expected herd immunity), especially for the consumer-facing service industry. Although due to the lower base effect in 2020, the 2021 GDP growth will look ‘V’-shaped, actually it’s ‘K’-shaped (uneven across the economy/sectors), and the labour market may continue to be fragile.

The risk trade sentiment was also affected by CARES Act 3.0 for $1.9T uncertainty amid Capitol Hill chaos over Trump's impeachment and the legislative nightmare to pass the same through a complex budget reconciliation process. Biden, on his part, is also trying for bipartisan agreement over CARES Act 3.0 and preparing for the infra stimulus & FY22 budget, but the latter may be further delayed from earlier scheduled Feb-Mar to May due to some roadblocks by previous Trump admin.

The market is now also questioning how much of these stimulus checks will go for discretionary spending as various surveys indicate that vulnerable Americans may prefer more for savings (rainy day) rather than unnecessary (discretionary) spending amid COVID/economic uncertainty. In China, the public was provided with some types of free shopping vouchers rather than direct checks to support discretionary consumer spending.

Locally, the Indian market may be also concerned about any negative rating/outlook action by global rating agencies because of the fiscally expansive budget.

On Wednesday, Fitch said in a report: Credit Impact of Indian Budget Hinges on Growth Outlook

India’s budget presented by the government on 1 February, points to a loosening of fiscal policy to support the country’s ongoing economic recovery from the pandemic and will consequently lead to a rise in public debt. The debt/GDP trajectory is core to our sovereign rating assessment, meaning higher deficits and a slower consolidation path will make India’s medium-term growth outlook take on a more critical role in our analysis.

India entered the pandemic with little fiscal headroom from a rating perspective. Its general government debt/GDP ratio stood at 72% in 2019, against a median of 42% for ‘BBB’ rated peers. We revised the Outlook on India’s ‘BBB-’ rating to Negative, from Stable, in June 2020, partly owing to our assumptions about the impact of the pandemic on its public finance metrics. The budget’s deficit projections for the fiscal years ending March 2022 (FY22) to FY26 are about 1pp a year above our previous estimates, which could make it more challenging to put debt/GDP on a downward trajectory.

We now expect public debt/GDP to rise above 90% of GDP over the next five years, based on the revised budget targets and with our other previous rating assumptions remaining unchanged. However, recent reforms and policy measures, including those announced in the budget, could also influence our growth expectations and, thus, our debt trajectory forecasts.

Our latest economic outlook projected growth at 11% in FY22 then at around 6.5% a year through to FY26. This pace of expansion reflects base effects and the closing of output gaps after the pandemic shock. In aggregate, the 2021 budget has the potential to lift growth prospects. Higher expenditure will support the near-term recovery and increased infrastructure spending could boost sustainable medium-term growth rates.

Labour market and agricultural reforms that were legislated in September 2020 could also lift medium-term growth. However, recent adverse court rulings have highlighted implementation challenges to these reforms and there is a risk that fiscal spending could also fall short of planned levels. Meanwhile, the budget’s proposed increases in import tariffs could dampen trade and economic growth.

Although there are implementation risks around aspects of the budget, we regard the government’s overall fiscal projections as broadly credible. The budget’s higher deficit forecasts are partly driven by positive steps toward greater transparency, as previously off-balance-sheet items, such as loans from the Food Corporation of India, have been brought on budget.

The extent to which policy changes address weaknesses in India’s financial sector will also influence the country’s medium-term growth potential. We believe the proposed injection of INR200 billion (USD2.7 billion) of new capital into state banks will be insufficient to alleviate the anticipated incremental stress on capital levels in 2021 and 2022. State banks are likely to continue to experience asset-quality problems, weak profitability, and small capital buffers, and, as a result, we project credit growth to remain soft in the absence of further government action.

On the other hand, the proposed establishment of an asset reconstruction company and an asset management company to deal with bad banking sector assets should be credit positive, dependent on the details of its structure and implementation. Plans to privatize two state banks could also be significant but would require changes to the Bank Nationalization Act, which would add to implementation challenges. Fitch will take a considered view of any changes to the Act and take necessary action should these have broader implications for the sector or our support assumptions.

Overall, Fitch is concerned about politically difficult structural policy reform implementation and actual GDP growth in the coming years, so that the debt/nominal GDP ratio gradually comes down as per government projections, which is the main issue in India’s rating. As India is paying almost 45% of its operating revenue for loan interest payment, going forward along with higher GDP growth, higher revenue and higher deleveraging (monetization of PSU assets) are key to its fiscal balancing and stimulating the economy by creating infrastructure.

On the economic data front, India’s CPI slips to +4.06% in Jan, sequentially from +4.59% in Dec (y/y), below market expectations of +4.45%, and was at a 16-month low, almost at RBI target of +4.00%. The Jan slump in headline CPI was mainly led by a drastic fall in vegetable/food inflation due to seasonal factors and may be transitory. Also, higher retail petrol/diesel process (transportation fuel) may cause higher CPI and core CPI in the coming days.

The Indian core inflation (Core CPI) was unchanged at around +5.7% in Jan (y/y) and consistently over RBI’s unofficial target of +4.00%. Overall, even if headline CPI dips consistently below 4.00% in the coming days, there is virtually no policy/transmission space for further rate cuts below 4.00%.
India: Headline CPI

India: Core CPI

On Friday, another data shows that India’s industrial production (IIP) rose sequentially in Jan by +1.0% against a contraction of -2.1% in Dec (y/y) and was higher than the market expectations of -0.2% (contraction). Overall, the IIP data shows that India’s manufacturing activities/output is still hovering just below pre-COVID levels and may also be saturating as the initial re-opening/festival season pent-up demand is exhausted.

India: IIP

In Jan, the Indian unemployment rate (unofficial) also nosedived to +6.5% sequentially from +9.1% in Dec as the economy/country is now running at over 95% pre-COVID levels and immigrant rural/small town laborers again rejoined their workplaces, especially in various factories.


Indian unemployment rate

On Thursday, Nifty gained +0.44%- helped by RIL as Amazon (NASDAQ: AMZN ) eventually moved SC for the FRL issue. The market is now expecting a favourable judgment for FRL-RIL M&A. The Indian market risk sentiment was also boosted by the India-China army disengagement agreement at Ladakh LAC.

On Friday, the Indian market was helped by banks & financials and techs, while dragged by automobiles, infra, media, energy, pharma, FMCG, and metals. Nifty was helped by ICICI Bank (NS: ICBK ), Infy (higher investment in IdeaForge an Indian startup focused on drones), HDFC (NS: HDFC ), HDFC Bank (NS: HDBK ) (higher COVID loan), Axis Bank (NS: AXBK ), Adani (NS: APSE ) Ports, SBI (NS: SBI ), and Wipro (NS: WIPR ). Nifty was dragged by ITC (NS: ITC ) (subdued report card), RIL (FRL deal uncertainty as Amazon knocks SC), Bharti Airtel (NS: BRTI ), HUL, Sun Pharma (NS: SUN ), TCS (NS: TCS ), Kotak Bank, and Titan (NS: TITN ).

Overall, Nifty surged +1.60% for the week, after the previous week’s mega rally of +9.46% amid ‘no harm’, but ‘dream budget’; now going forward, the implementation of structural reforms like PSU bank privatizations, other PSU assets selling/monetization, creation of a ‘bad bank’ (super ARC in PPP/government guarantee) is the key. In other words, the market will now watch the proper implementation of bold policy reforms proposed in the budget and political capital of the Modi-led BJP admin to implement that.

Technical View: Nifty and Bank NIFTY Futures

Nifty 50 Futures (INDIA 50)

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