What the market knows

The rally in the broad market and the continuing attraction of mid caps indicate the present economic woes might be temporary

Baiters of Prime Minister Narendra Modi have been quick to blame demonetization for the GDP growth slowing to a three-year low of 5.7% in the June 2017 quarter. The trigger seems to be the Reserve Bank of India annual report coincidentally coming around the same time. It revealed only about 1% of the old currency was not returned to banks. There could be two reasons for depositing of most of the cash in circulation. First, only a handful of people might be in a position to generate, store and utilize the liquidity. The possibility is that they are at the top of the pyramid and rented the accounts of their field force. Second, many might have already laundered the loot through a web of channels. The discovery of nearly two lakh shell firms and the restriction on trading imposed on more than 300 listed companies should be counted as major successes apart from the revival of the dormant zero-balance Jan Dhan accounts. There is some quibbling whether 90 lakh new tax payers were added or about 50 lakh as mentioned in the second Economy Survey. The controversy is silly. What is important is the amount of income declared rather than the number of tax payers. The puzzle, however, is why the impact of the swap of currency should be felt after a quarter. The GDP grew 6.1% in the January-March 2017 period over a year ago, when the intensity of the fallout was the highest, with the 50-day period for exchange of old notes closing in the previous quarter.

The disruption in the rural economy could be responsible for the lag effect. Last year’s normal rainfall resulted in supply glut. Prices of many farm produce crashed. The distress of farmers after two consecutive years of drought, therefore, did not ease, affecting karif sowing beginning April. The roll-out of the goods and services tax from the second quarter of the current financial year forced manufacturers to cut production on dealers’ reluctance to restock. Companies were busy shedding off past excesses on fear of being declared insolvent. Construction stalled as new houses now have to be Real Estate Regulation and Development Act-compliant. A strong rupee and the churn in the tech sector hurt export services. Infrastructure initiatives of the government such as Smart Cities and Digital India are at the planning and ordering stage, with execution of many yet to commence. Therefore, the growth in industrial production, at 1.2%, and construction, at 2%, was lower than that of farm output, at 2.3%, in the quarter. If manufacturing has slumped and food inflation is rearing its head due to floods and patchy rains in different pockets, why is the market not bothered? The benchmark index of the BSE once again crossed 32,000 and of the NSE 10,000 after retreating amid a spell of volatility triggered by North Korea’s missile tests. Yet, investors have been selective in their approach to leaders in recognition that many of them have to diversify to bolster earnings, a risky exercise. Only a handful of index constituents are attracting most of the inflows. Interestingly, these stocks get most of their revenues from the domestic market.

Nearly 30% of the NSE Nifty 50 hinge on exports for a major part of their revenues. After capturing a commanding share of the local market, other companies in the index too, have been seeking international orders. The quest for dollar-denominated income made sense when the rupee was depreciating. The acceleration of foreign direct investment since the launch of the Make-in-India initiative and foreign portfolio investors’ increasing interest in debt due to high real interest rates have boosted the Indian currency. Many export-oriented sectors are facing headwinds. Mid- and small-sized companies are getting better discounting despite the general belief that large companies are better placed to absorb external shocks. Domestic funds, buoyed by cash that turned formal, are betting on these counters. Only about 10% of the 100 companies in the S&P BSE Mid-cap Index depend on exports. Many medium and small companies are in nascent sectors or emerging from segments dominated by the informal economy. There is scope for them to run at a faster pace. The low base effect of the GDP growth rate in Q1 and possibly Q2 of the current fiscal could also be a launch pad for recovery going ahead. The spurt in spot prices of electricity points to the bottoming out of the economy. The increase in August in CPI due to food articles and WPI largely by metals implies the slump in demand post DeMo and GST turbulence is fading. Fortunately, interest rates are not so low as to push the RBI to reverse the course. No wonder, the market continues to remain bullish on the India Growth Story.

By Mohan Sule