India’s Nifty 50 slumped on subdued global cues as China’s coronavirus panic spreads further coupled with fading hopes of any big-bang fiscal stimulus by PM Modi in the forthcoming budget
The Indian stock market (Nifty) slumped almost -1.15% to close around 12110 Monday on subdued global cues as China’s coronavirus panic spreads further coupled with fading hopes of any big-bang fiscal stimulus by PM Modi in the forthcoming budget. There is still uncertainty about India’s income tax cut (fiscal stimulus) and RBI may not cut further till H1FY21 due to lack of adequate policy space.
On early Monday, Dow Jones 30 Futures slid almost -1.50%, while China-A50 Future plunged almost -5% since Friday. On early Monday, Nifty was dragged by China sensitive metals and energies (oil & gas) as-well-as banks, while supported by pharma on the defensive bet. But Nifty got some support last week on hopes of the personal income tax cut and LTCGT relief in the budget and outperformed its global peers.
Overall, Nifty ended almost Flat in Jan as it was dragged by U.S.-Iran geopolitical tensions, Chinese coronavirus panic, mixed earnings, while helped by U.S.-China phase one deal signing and hopes of a mega fiscal stimulus by the Modi government in the forthcoming budget (1st Feb, Saturday).
The risk-trade was under stress on increasing panic about China’s coronavirus (nCoV-2019):
As per the latest official report, till early Monday, China’s coronavirus death toll jumped to 80 from 41 with 2744 confirmed cases. But various unofficial reports and estimates are suggesting much higher cases and possible deaths. Meanwhile, China extended its Spring Festival public holidays to February 2 amid coronavirus outbreak and all schools will be closed at least 14th Feb. Also, Wuhan’s Mayor confirmed early Monday that due to the Chinese Lunar New Year and Coronavirus, more than 5 million people left Wuhan and 9 million people remain in the city which is under lockdown.
The Wuhan Mayor also projected another fresh 1000 confirmed nCoV (Coronavirus) cases. The Chinese Premier Li was appointed as head of the CPC Central Committee leading group to combat Wuhan Coronavirus and he may visit Wuhan soon personally to take stock of the situation and lead from the front.
Till Sunday, the U.S. confirmed a total of 4 cases of nCoV officially, while unofficially the figure is 5 and may rise further. China also warned nCoV is getting stronger and infections could rise. In brief, the Chinese coronavirus epidemic is fast turning into a global pandemic.
India’s Nifty surged Fri on positive global cues and hopes that PM Modi will keep both Dalal Street and Real Street happy by cutting income tax and providing LTCGT relief in the budget to bring the economy out of stagflation:
The Indian stock market (Nifty) surged almost +0.40% Friday on positive global cues (amid reduced coronavirus panic) and hopes that PM Modi will keep both Dalal St and Real St happy by cutting income tax and providing LTCGT relief in the forthcoming budget (1st Feb). As a reminder, at present, the Indian LTCGT (long term capital gains tax) is 10%, if investments held over one year, while STCGT (short term capital gain tax) is 15% if investments sold within a year. Previously, there was no LTCGT, but in the FY18 budget (wef April’18), the Modi government has introduced the LTCGT as a ‘contribution from the capital market for the development of nation’ (without the benefit of inflation indexation on profits above Rs.1.00L/around $1400).
As a pointer, soon after late 2016 DEMO, the Modi government was supposed to introduce the LTCGT in a bid to tax the ‘black/unaccounted money’, which was deposited (in high-value demonetized 500/- and 1000/- notes) by the people in the bank as a way to convert the same into so-called ‘white money’. A significant portion of that ‘black money wealth’ found its way to various financial instruments including Stocks, MF, insurance policies and bonds. At that time, the Indian government was also thinking to introduce LTCGT as it was not possible to find out and tax each & every small ticket ‘black money’ deposited in millions of bank accounts.
But considering the DEMO bloodbath of the stock market, the government refrained from such an ‘anti-market’ move but eventually introduced it after a year when the stock market stabilized and making new highs (due to power of DEMO liquidity).
Now, in 2020, to support market sentiment, the Modi government may either extend the time period of LTCGT from above one year to above 2/3 years or hike the threshold limit from Rs.1L to 2L or scrap the same altogether. The Modi government may also provide some relief to the STCGT rate (say reduce to 10% from 15%) and ETF (to hike tax-deductible allowance from Rs.1.5L to 2.0L or higher with the benefit of indexation).
Overall, considering all the narratives of DEMO and revival of stock market investment sentiment, the government may hike the LTCGT threshold time from above one year to above two/three years.
To boost consumption, the Modi government may also cut/recalibrate personal income tax. But as per reports, the PMO has not taken a firm decision in this regard till Friday as there is not much fiscal space. Although officially the FY19 fiscal deficit was around +3.4%, in FY20 the target was 3.3%, it would be likely around 3.8%-4.00%.
But if we consider the legacy issues of off-balance-sheet deficits -mainly FCI food subsidy bill payment, National Small Savings Fund (NSSF) loans to public entities and government-serviced bonds, which are not reflected properly as per cash accounting policy instead of normal accrual accounting policy, the actual Indian Federal fiscal deficit would be much higher around +5.5%, even after considering additional RBI payout.
There is a dilemma within the Modi government about more fiscal stimulus in the form of personal tax cuts to boost consumer spending after the corporate tax cut as the later not helped in boosting consumer sentiment/spending. Usually, such corporate tax cut boost their bottom line resulting in higher cash payout (in the form of higher dividends, bonus shares, and buybacks) rather than capacity addition/expansion or higher employee remunerations.
The Modi government is basically fiscally hawk; i.e. not ready for any big-bang fiscal stimulus as higher fiscal deficits may cause India’s rating downgrading, which is now just above the junk. Thus the Indian government may go for a small-ticket cut in personal income tax without some exemptions so that at the end of the day, middle-class earners have some disposable income in hand to boost consumer spending and stimulate the economy, which is under stagflation (lower growth, higher inflation, and higher unemployment).
In Dec, the headline CPI (which now RBI follows officially under new governor Das) jumped to +7.4% (y/y) from Nov figure of +5.5% due to almost hyper-inflation in food (12.6%), vegetable inflation (+60.5%) and pulses (+15.44%). Although the headline CPI was way above the RBI target of +4% (against the global norm of +2%), the core CPI remains below 4% for the last three consecutive months. In Dec, the Indian core CPI inched up to +3.726% from prior +3.487% in Nov (y/y).
As in economics, core CPI is usually proportional to the country’s GDP growth, the Indian GDP growth rate may have accelerated in the 3rd QTR from the terrible figure of +4.50% recorded provisionally in 2nd QTR (Q2FY20). The core CPI fell from a high of +4.362% in Jan’19 to +3.468% in Oct’19 in line with the fall in GDP growth rate. Now from Nov’19 the core CPI again edged up, indicating that the worst of GDP growth may be over for the time being.
In India, food inflation is a factor of some structural issues rather than RBI monetary policies. The same is almost true for the headline CPI as the massive devaluation of rupee (from USDINR 8.00 in 1975 to 70 in 2019) was mainly for government policies and various issues. The resultant surge in imported inflation; especially for oil (petrol and diesel) may be the main culprit behind today’s high-cost Indian economy.
In 1989, Diesel (used for transportation) price was around Rs.3.50/Lt and now (2020-Jan), it’s around 71.00/LT; thus the overall price surged almost +1929%, far above the wage growth in this period (approx 30-years). In brief, there is no price stability in India, especially after 1990 and it’s like a hyperinflation scenario, due to devalued currency (the economy is mainly import oriented), higher tariffs (extremely high import duties-India is the ‘maharaja of tariffs’-as per Navarro/U.S.), low domestic productivity and extremely high borrowing costs. In 1975, India (GDP: $0.98T) and China ($1.63T) were almost at par (USDINR=8.00 and USDCNY=1.37). Now after 45-years, India stands around $2.85T and China almost $15T; USDINR=71; USDCNY=7 (after Trump trade war).
Although INR is now almost 10 times devalued against USD than the Chinese Yuan (CNY), still India is far behind China’s export machine and China is now the world’s 2nd largest economy, almost 5-times that of India, mainly for its goods export capability. China is far ahead of India on productivity and technology and India’s devalued currency may be also negative for goods export as the cost of imported raw materials is high.
India has an advantage in service (IT) export due to favorable demography with better English speaking and devalued currency (lower wage). But to get a real boost in export, India needs to stimulate its goods export and formulate policies accordingly including industrial infrastructure.
As the domestic Indian economy (domestic consumption) is already saturated, the country needs to stimulate goods export activities (manufacturing). Traditionally, India’s domestic consumption stories were largely ‘black/unaccounted/fraud money’ oriented. But after various actions against black money even before DEMO in 2016, and deleveraging drive (from 2015), the domestic consumption story; especially at the high-value end suffered almost 30%. The subsequent redistribution of wealth is taking time (at least 5/10-years of the political cycle).
And typically, India’s NPA crisis got aggravated after this DEMO and deleverage and now coupled with a slowing economy, growing unemployment, and surging inflation, Indian banks are now facing corporate (both legacy and current) as-well-as MSME and retail NPA. Previously, banks granted loans to even financially weak corporations or individuals because of their off-balance-sheet strength (knowledge of black money or wealthy guarantors/family link). Now, after DEMO, those black money links are no more ‘workable’ and subsequently NPA surged.
India is now facing a crisis in housing loans, both sub-prime and standard because of the slowing economy, job/salary cuts, growing unemployment, and affordability. The average housing price is much higher than average income levels proportionately and this is creating more banking NPA. As huge political black money is involved in many big housing projects, there is no significant price correction in the housing segment, especially at the high end. The question of housing affordability along with money laundering (allegedly by builders/promoters), unholy nexus between bankers and builders/borrowers may be the main reason behind today’s HFC/NBFC crisis.
So, primarily there are some structural along with some cyclical issues behind today’s slowing Indian economy and thus the government needs to do further deep structural reforms to treat the actual ailment rather than symptomatic treatment. India needs some deep structural reforms and deregulations along with fiscal (tax cut-both personal tax and GST) as-well-as monetary (RBI) stimulus. And at the same time, the government needs to control/cut some unproductive expenses as almost 65% of gross revenue now goes for a huge salary bill (government employees-40%) and interest payment on loans (25%).
In any way, currently, the scope of both fiscal and monetary stimulus is quite limited. The government can’t cut personal income tax in a big way due to limited fiscal space, especially after corporate tax cuts and slowing economy (lower revenue). Also, after 135 bps cut in 2019, RBI has only limited space for another 40 bps in FY21 to lower the rate to +4.75% (2008 GFC low levels) from the present +5.15%. But RBI will not use its limited weapon unless there is a real exigency. Also, at present, despite RBI’s 135 bps cut in the last year, very little has been transmitted to the borrowers on the real street.
Moreover, there seems to be a dead-end for the government in cutting rates further for the small savings instruments. This is a political/policy issues as it’s associated with general public savings in a country where little/almost zero social security. Also, the Indian government mainly gets its funding from domestic financials (lenders), who are dependent on banks and small savings schemes’ deposits.
Thus, RBI will wait for better transmission of previous rate cuts by banks and also for lower headline inflation (CPI) and government’ budget/borrowing plan before going for any meaningful rate cuts. In brief, RBI may be going for less dovish hold in Feb and going forward, it may cut only -0.15% symbolically to keep the RBI rate at around +5.0%. The RBI may keep its last weapon of -0.25% cut in its arsenal to deal with any exigency and may also wait till H1FY21 as headline CPI falls and GDP growth recovers to some extent.
Keeping this stance, on Friday (24th Jan), in an academic speech, the RBI governor Das urged for more structural reform and fiscal stimulus rather than monetary stimulus as currently there is little fiscal space.
The RBI governor Das said while narrating the evolution of RBI and its role: Selected texts
One of the major challenges for central banks is the assessment of the current economic situation. As we all know, the precise estimation of key parameters such as potential output and output gaps on a real-time basis is a challenging task, although they are crucial for the conduct of monetary policy. In recent times, shifting trend growth in several economies, global spillover effects and disconnect between the financial cycles and business cycles in the face of supply shocks broadly explain why monetary policy around the world is in a state of flux. Nonetheless, a view has to be taken on the true nature of the slack in demand and supply-side shocks to inflation for the timely use of countercyclical policies.
We, in the Reserve Bank, therefore, constantly update our assessment of the economy based on incoming data and survey-based forward-looking information juxtaposed with model-based estimates for policy formulation. This approach helped the Reserve Bank to use the policy space opened up by the expected moderation in inflation and act early, recognizing the imminent slow down before it was confirmed by data subsequently. Monetary policy, however, has its own limits. Structural reforms and fiscal measures may have to be continued and further activated to provide a durable push to demand and boost growth.
In my previous talks elsewhere, I have highlighted certain potential growth drivers which, through backward and forward linkages, could give a significant push to growth. Some of these areas include prioritizing food processing industries, tourism, e-commerce, start-ups and efforts to become a part of the global value chain. The Government is also focusing on infrastructure spending which will augment the growth potential of the economy. States should also play an important role by enhancing capital expenditure which has a high multiplier effect.
Concluding Remarks
Monetary policy frameworks in India have thus evolved in line with the developments in theory and country practices, the changing nature of the economy and developments in financial markets. Within the broad objectives, however, the relative emphasis on inflation, growth and financial stability has varied across monetary policy regimes. Although global experience with financial stability as an added policy objective is still unsettled, the Reserve Bank has always been giving due importance to financial stability since the enactment of the Preamble to the RBI Act.
The regulation and supervision of banks and non-bank financial intermediaries has rested with the Reserve Bank and has kept pace with the prescribed global norms over time. More recently, the focus of financial stability has not only confined to regulation and supervision but also extending the reach of the formal financial system to the unbanked and unserved population.
Apart from financial inclusion, there is also a focus on promoting secured, seamless and real-time payments and settlements. This renewed focus on financial inclusion and secured payments and settlements is not only aimed at promoting the confidence of the general public in the domestic financial system but also improving the credibility of monetary policy for price stability, inclusive growth, and financial stability.
Bottom line:
There is still significant concern about the fate of the Indian 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 amid 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 430 at Q2FY20, translating a PE of around 28.37 at Nifty levels of 12200 (fresh lifetime high); the Nifty PE is now at the historical bubble zone, from where we can easily expect a 5-10% correction in the coming days.
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 12200 levels of Nifty, the market is now discounting an EPS of 600 by FY21 (at normalized PE of 20), which may be far stretched from expected FY20 levels of 450 EPS as it’s assuming a CAGR of almost 33% by next one year, whereas the average CAGR of NIFTY EPS is now below 10% for the last few years and around +12.5% in FY20 (expected).
The 33% projected EPS CAGR growth for FY21 in 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 (range) of Nifty should be around 10000-12500 in 2020.
Now the focus would be whether the Modi government fired another bazooka in the form of a huge fiscal stimulus by cutting personal income tax, GST rates and small savings rate in the forthcoming budget despite limited fiscal space. The government will go for the personal income tax cut (fiscal stimulus worth of Rs.1.75T if the fiscal deficit will stay around +3.5% in FY20/21, which is unlikely.
India now needs GST reform (simplification with only one single rate at 16.5% or goods tax rate at 18% and service tax at 15%), income tax reform/cut, land & labor reform (higher productivity) and an urgent need to control surging population (1/2 Child policy like China) coupled with illegal immigration into the country irrespective of any religion. The Modi government should focus more on economic and structural reforms along with the creation of credible leading economic data (like unemployment rate/reports, wage growth, retail sales, and housing data) in lieu of CAB/NRC, intended to shift the focus of the public to politics rather than economics.
It’s true that there is still now no credible ‘national leader’ to take on PM Modi (at national levels), but it’s not true at state levels. Modi/BJP/NDA is losing popularity and legislative powers at various state levels across the country very fast for unnecessary controversy like CAB/NRC, which nay haven taken in haste and without due considerations of public sentiment at large. This CAB/NRC and economic slowdown is now an unexpected ‘prize’ for the oppositions at least at state levels, also hampering implementations of various legislations /reforms taken at Federal levels, making them virtually ineffective.
All these political issues along with telecom AGR fiasco maybe now showing the importance of ‘statesman’ Jaitley (former FM) in the ‘team Modi’, ideal to handle crisis from economics to politics.
Technical View (Nifty, Bank Nifty, and USDINR):
Technically, whatever may be the narrative Nifty Future (Feb) has to sustain over 12375 for a further rally to 12435*/12495-12575/12695 and further to 12815*/12880-12975/13055* in the near term (under bullish case scenario).
On the flip side, sustaining below 12355-12335/12305 Nifty Future (Feb) may fall to 12200*/12090-11940/11880* and further to 11800/11760*-11650/11590 in the near term (under bear case scenario).
Technically, Bank Nifty Future (Feb) has to sustain over 31500 for a further rally to 31750*/32000-32200/32400* and further to 32600/32800*-33055/33325 and 33600*/33950-34150/34350* in the near term (under bullish case scenario).
On the flip side, sustaining below 31450 Bank Nifty Future (Feb) may fall to 31150/30950-30675*/30350 and further to 30100/30000*-29850/29600* in the near term (under bear case scenario).
Technically, USDINR (spot) has to sustain over 71.55 for a further rally to 71.95*/72.15*-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 71.35-70.90*, 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).
