Three scenes for 2018

Will recovery pick momentum or political instability derail reforms? Will liquidity boost prosperity or create bubbles?

Stepping into the New Year, investors are confronted with three uncertainties. The first is the direction of the stock market. Second is the looming inflation. Third is the shadow of the poll season. In 2017, the market bet on the bottom-up effect for the economy after the second disruption, this time by the roll-out of the goods and services tax, in seven months. Many companies shed assets to become lean. The issue is if the higher base will crimp the rate of return in 2018. As the year ended, crude and commodity prices caused concern. Projection of interest rates were muddied by mixed signals. The pressure of rising food prices due to heavy rains in some parts, higher manufacturing costs and government’s need to borrow on lower tax revenues on shifting most items to the lower GST bracket on one hand and the pull of a strengthening rupee and banks’ deposit-rate cut spree amid plenty on the other. The next wave of reforms will have to skirt the model code that will be in force at different times of the year as elections are slated in eight states. There are likely to be three scenarios for investors. The most favorable is the global economy, led by the US and Japan, keeping its momentum, buoyed by pent-up demand after more than a half-a-dozen years of slump. The fallout is the pull-up of the euro region, cranking up of China’s export machine and lifting of Indian tech exports. Pay commission payouts, better farm realization in an election year and orders for infrastructure projects ensure liquidity inflows into low-cost houses and consumer durables. The ripple effect bolsters lagging sectors, spurs credit growth and pares bad loans.

Oil prices remain range-bound as users diversify sources but breathe life into the Gulf economy. Mines ramp up output, tempering prices. Domestic interest rates cool after a bout of volatility on flood of funds from profit booking and banks’ desire to push lending. Foreign investors continue to look at India to widen the portfolio base. The currency appreciates due to the steady foreign direct investment as more steps are taken for ease of doing business and on BJP winning Karnataka and retaining all the other major states. Higher import bill and the Federal Reserve’s measured rate hikes as the US economy’s recovery consolidates,however, keeps the gains under check. The crunch due to lower tax mop-up and increase in supply-side expenses is met by aggressive divestment of PSUs. The second scenery suggests flat or marginal returns as the stock market’s surge moderates to allow earnings to catch up. Inflation stabilizes at a slightly elevated level as food and metal prices are capped by increased production. The rupee turns volatile on mixed signal from the Fed on inflation even as the US economy keeps ticking. Exporters’ hedging costs go up and the Reserve Bank of India’s task of managing the supply and cost of the Indian currency becomes complicated. Tax collection bottoms out and recovers as teething issues in GST execution are taken care of. The BJP fails to wrest Karnataka and looks likely to lose Rajasthan but keeps in fold others and bags some small north-eastern states, throwing the run-up to the Lok Sabha polls in 2019 open. The reduction in other income of banks due to the underlying threat of higher interest rates is compensated by higher growth in credit as purchasing power gets a boost due to improved wages and farm support prices.

The slowdown in foreign fund inflows because of incremental reforms is countered by mutual funds as valuations turn affordable. With fuels under GST limiting the flexibility to tinker with Central and state levies to shore up the treasury, more and more PSUs are put on the block at attractive discounting. Stricter due diligence while lending prompts issuers to become transparent to tap the open market at reasonable prices before it is too late. Investors have an option to choose from debt and equity at realistic return expectation. In the third scene, everything that is possible goes wrong. Oil prices spiral, fueling domestic inflation and straining the country’s balance sheet. The surge in the US market comes to a halt as the buying triggered by the personal tax rate cut propel valuations to bubble territory, prompting the Fed to undertake aggressive rate ramp-ups. Central banks of emerging economies, bloated with foreign reserves, too follow suit. Markets around the world tumble due to credit crunch. China is the worst hit. Middle East is whacked by democracy protests and US-North Korea war of words escalates. BJP loses most of the states, giving rise to political instability. Exports collapse even as the rupee weakens. A scant monsoon aggravates agrarian distress. Hopefully, 2018 will have some elements of the first two settings, balancing each other and keeping the market afloat.

Mohan Sule