Indian bourses continued to witness northward trajectory attaining new all time highs in Jan’18, mainly swayed by smart rally in global indices. The benchmark indices Nifty and Sensex clocked a handsome gain of 4.7% MoM and 5.8% MoM, surpassing the psychological marks of 11,000 and 36,000, respectively. While the FIIs were on tenterhooks in earlier months due to soaring crude prices and skewed corporate earnings, sign of economic revival led by decent growth (6.8%) in core sector for Nov’17 (reported in first week of Jan’18) and healthy up-tick in 3QFY18 corporate earnings reported so far aided to attract foreign flows into domestic markets. Notably, the FIIs infused Rs138bn in Indian equities in Jan’18 compared to outflow of Rs59bn in Dec’17. Further, total credit growth and non-food credit growth also have been encouraging for last two months by showing a healthy growth of 8.5- 10%, which suggests an imminent improvement in private capex.
Most importantly, 3QFY18 corporate earnings reported by companies till date appear healthy and in many cases, the companies were able to exceed the street expectations. Hitherto corporate earnings are estimated to have grown by over 20%, mainly on account of base affect and pick-up in consumption/infrastructure activities across the country.
Strong Global Rally Aided Indian Indices
A smart MoM rally witnessed by the Indian bourses was in tandem with global rally, as visible economic revival in the US, Asian and European nations led to increased inflow to equities. Further, recent corporate tax cut by the Trump administration instilled confidence among the investors on likely improvement in earnings in USA based companies due to tax cuts.
Higher Crude Price & Reversal of Interest Rate Cycle Remain Key Concerns
A continuous surge in Brent prices to over US$70/barrel mark, led by production cuts by OPEC and non-OPEC nations, is a major headwind for Indian equities as it can potentially have a huge impacton fiscal deficit and inflation front. Recent upsurge in CPI (5.21% in Dec’17, which is 17 months high) is broadly accounted by higher oil prices. Further, a gradual increase in interest rates in the US and others (expected to follow suit sooner or later) can pose a big challenge for Indian markets as higher real interest rate has been the prime reason for Indian markets to witness robust foreign inflows over last couple of years. However, we believe crude prices to correct, as compliance of production discipline by all members seems to be unsustainable.
Budget 2018; a Prudent Balance between Fiscal Discipline and Economic Growth
While Budget 2018 was broadly focussed on four key foundations of economy i.e. Agriculture, Infrastructure, Employment and Healthcare by offering many sops and higher allocations, the Finance Ministry has aptly targeted fiscal deficit at 3.5% and 3.3% for FY18E and FY19E, respectively. We believe that with the likely upsurge in direct and indirect tax collections along with correction in crude oil prices can essentially aid the government to meet its targets. However, any shortfall in tax revenue and sustained higher oil price can put government’s credibility at stake.
LTCG Tax on Equities – A Temporary Dilemma
Long Term Capital Gains (LTCG) of 10% for equity and equity-oriented investments for amount exceeding capital gains of Rs1 lakh has a sentimental impact on the investor. The tax will be applicable based on cost prices prevailing as of January 31, 2018 for assets held before January 31, 2018, which will prevent any large-scale sell-off in stock markets. While LTCG tax has been imposed, there is no tinkering on Securities Transaction Tax, which makes India as probably only country in the world to have both taxes at the same time. Even grandfathering of cost prices for LTCG was unable to prevent knee-jerk reaction in the stock market especially a sharp fall in overheated mid and small cap indices. Despite the negative sentimental impact of this tax for the investors who treat equity as an asset class, it still offers the best inflation-adjusted post tax returns over the medium to long term.
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