Liquidity injection

Capital infusion into PSU banks, hike in MSP for kharif crops and cut in GST rates lift large caps

A striking feature of the recent rally in large caps that took the benchmarks to lifetime highs is the role of domestic institutional investors. Foreign portfolio investors are reducing their exposure to equities since August 2017. More stocks were liquidated by them than bought in the first six months of the current calendar year after being net buyers in the previous three years. In contrast, mutual funds’ net equity investment was up 30% between January and June over the same period a year ago. As the US and China respond with tit-for-tat import duties, countries are going to look inward. The trend of subsidizing home producers even as import barriers are being pulled up is pushing out overseas investors, who will prefer to operate within their boundaries rather than risk taking money outside. Countries will be left no choice but to manipulate their currencies to achieve growth. How they do so will depend on their orientation. China intends to loosen money supply to depreciate the yuan to make exports attractive even in the face of higher duties. India wants to prop up the rupee to slow down the flight of capital to pay the import bill. The US Federal Reserve has taken a pause from hiking interest rates. A strong dollar will push American exports out of competition.

Mutual funds do not seem unduly perturbed by the macro-economic headwinds. Equity scheme folios have increased 30% and those of exchange traded funds ex-gold 60% over the June 2017 quarter.  Cash has to be deployed. Many large caps had yet to participate in the rally and looked moderately priced compared with their smaller peers. The first wave of June 2018 quarter results underlined their capabilities and outlook. The reorganization of market-cap groupings, as per the Securities and Exchange Board of India mandate, has resulted in the downsizing of several stocks. Schemes whose selection is based on the criterion of market value had to shuffle their portfolios. With the shrinking of availability, the search has intensified for value buys by large-cap funds that had become lighter after many of their picks became mid caps. Big-sized companies are ready to run after spending most of the last year ensuring that their distributors and suppliers become GST-compliant to claim input tax credit. The capital market regulator’s increased surveillance has put off investors from small caps. A portion of the profit booked by exiting from these counters is making its way into large caps. A massive fiscal stimulus has been pumped into the economy. The minimum procurement price of crops that will be sown in April-September will be 50% more than the cost of production. Karnataka is the latest state to waive farm loans, writing off Rs 34000 crore. The depletion of the treasury of states can be expected to be made good by the buoyancy in tax revenues as the rural economy embarks on a spending spree.

With the worry about recovery vanishing, banks will have to make lower provisions and will have more funds to lend. Alongside, the clean-up of books by tightening the bad loan recognition norm, shepherding defaulters to the insolvency process, initiating corrective action against worst-case-scenario banks and infusion of capital by the Union government are shaping up PSU lenders to meet the increased demand for credit. Creating a favorable atmosphere for consumption is the latest round of reduction in the indirect tax rates. In a year since implementation, cement, air-conditioners and large screen televisions are the only mass-based items in the highest slab of 28%. Trends suggest the economy has not only recovered but is picking up momentum, too. The services sector recorded a 21-month high growth in July. The thrust on infrastructure and housing segments has spurred demand for steel (output up nearly 3% end June 2018 over a year ago) and cement (12% increase). Monthly electricity generation is the highest ever. Sales of passenger cars rose 8% to an all-time high of 3.3 million and two-wheelers 16% to cross 20 million. The good response to recent IPOs suggest availability of funds for investing. The tailwinds of the festive season are around the corner. The US-EU accord on tariffs has bolstered hopes of cooling down of the trade-war rhetoric. Oil prices look unlikely to climb up any further, having lost over 5% in July. The downside to the upbeat mood are corporate governance issues that might crop up, surging valuations of large caps and intensification of the panic selling of mid and small caps by retail investors, hurt by the recent brutal correction.

-Mohan Sule