In 2019, the Nifty 50 index of the National Stock Exchange delinked itself from the economy. Growth expectations for gross domestic product (GDP) kept sinking through the year, from over 7% to below 5%, yet the Nifty gained 12%, somewhat above its historical annual average.
There are at least three ways of looking at this dichotomy. The first is that stock markets represent our collective belief in the future of the economy, and the consensus view is that the Indian economy is going to turn around soon. The second is that, while the Nifty has done well, the rest of the equity market, not so. The third is that Indian markets have underperformed the rest of the world.
Each of these views has considerable validity.
Beginning with the third assertion, if you had invested in the Nasdaq 100, the tech-heavy US index, your dollars would have earned more than 37% last year. Factor in the slight drop in the rupee, of 2.4%, and you would have made nearly 40% for every rupee invested. The S&P 500, which represents the broader US markets, gained 28.71%. Add the rupee depreciation, and you would have made more than 30% in US equities.
Shares in other developing, or emerging, nations didn’t do as well as US shares, but did better than India. The MSCI Emerging Markets Index, iShares, gained 15.27% in dollar terms, or almost 18% in rupee terms. Whichever way you look at it, in a year when investors cheered on equities across the globe, Indian equities were also-rans.
When we examine the second statement, shares outside the Nifty did really badly. During 2019, the Nifty Smallcap 250 lost 9%. Even within the 50 shares that make up the Nifty, the bulk of the gains came from the top 10 stocks. For most Indian equities, 2019 was not a cheery year.
Finally, if we look at the first thought, that Indian equities reflect investor views about the economy, it seems as if the investing community is less hopeful about India than about the rest of the world. If one looks beyond top-tier stocks, the view is not hopeful at all.
We must keep in mind that the global cheer in equity markets, and asset prices in general, has been supported by extraordinarily low interest rates, set by central banks with extremely generous balance sheets. It seems highly unlikely that this expansionary policy will be reversed any time soon.
Indian financial assets are competing with those across the world. While domestic inflows into equities have increased over the last few years, our stock markets have always been sensitive to foreign inflows. In 2019 alone, foreign investors pumped ₹1 trillion into Indian equities. If this support were to vanish, because foreigners lose faith in our ability to generate economic growth, Indian stock markets could be severely affected.
There’s hope that the policies announced by finance minister Nirmala Sitharaman on 1 February will rescue the economy from its growth slump.
In October 2019, I argued in these pages that the primary problem in the Indian economy is a shortage of demand. The finance minister had just announced a cut in corporate tax rates, which I believed would do little to stimulate demand.
Companies with lower tax outflows and higher retained profits would have a greater ability to invest; however, the willingness to invest would depend on current capacity utilization and the outlook for future demand. So far, we have seen no signs that capacity utilization has improved, or that corporate boards are enthusiastic about future demand.
The central question then becomes what the budget for FY21 can do to restore consumption growth in the economy.
The budget for the current fiscal year— let’s call it Budget 19—has been challenging, to say the least. Its projections regarding tax collection were massively off, largely because economic growth was wildly overestimated. Nominal GDP growth was assumed to be 12%; in reality it has been closer to 7%. The revenue shortfall is estimated to be ₹2.5 trillion.
To help bridge this shortfall, the government hoped to garner funds from disinvestment in three public sector firms, Air India, Bharat Petroleum Corp. Ltd, and Container Corporation of India Ltd. The timelines for these processes looked overly ambitious, and the government has now conceded that no transaction is likely to take place before FY21 ends. The fiscal deficit targets will definitely not be met.
In addition, earlier this month, media reports suggested that the government would cut expenditure by ₹2 trillion to cope with the shortfall. A retired expenditure secretary recently told me that such a cut was not as alarming as it sounds, since every department builds substantial buffers into their annual spending plans. While that is a valuable insight, I think it would be fair to assume that a ₹2 trillion cut in budgeted expenditure would have some impact on the real economy at a time when we need more spending, rather than less.
If, instead, the government decided to stick to its spending programme, it would have to borrow more money from the market. However, this would put upward pressure on interest rates, which the Reserve Bank of India tried to drive down all year, in a bid to encourage private investment.
This didn’t go as planned: despite lowering the repo rate, at which banks borrow money from the central bank, the cost of corporate borrowing has barely budged, as banks have not been able to lower their cost of mobilizing deposits from their customers.
Budget 20 is stuck between a rock and a hard place. If it earmarks expenditure on the basis of slow growth in GDP and hence revenue, it will not be able to stimulate demand. If it plans for a larger stimulus, it will have to accept much higher interest rates, and give up any hope of priming the investment cycle. I think this is a fond hope in any case—the investment cycle will be driven by the pedals of consumer demand.
One obvious way to stimulate demand is to reduce income-tax rates, and there has been a great deal of speculation, almost a consensus, that Budget 20 will cut personal tax rates, and perhaps levies on capital gains, too.
In a recent interview to Mint, the erstwhile head of the National Statistical Commission, Pronab Sen, reminded us that only 15 million Indians pay income tax (bit.ly/2FSei14). These higher-income households, he believes, would spend only a fraction of the money they save in taxes. On the other hand, poor households are much more likely to spend any additional money they receive. Enhanced welfare allocations, for example via the Mahatma Gandhi National Rural Employment Guarantee Scheme, would yield a much more immediate bump in consumer demand.
The other route to pumping money into the economy is via government spending, on infrastructure, for example. This is easier said than done. Our infrastructure plans are dogged by problems with land acquisition, planning delays and poor coordination between the myriad departments involved. A broad-brush budget level plan will not work.
The concerned agencies would have to carefully identify projects from across the nation that are ripe for implementation, where the allocation of funds results in rapid work, and the consequent release of demand for goods and services into the economy. Frankly, I don’t think that Budget 20 can credibly signal an infrastructure push that will kick-start the economy.
The third possible stimulus would be a goods and services tax rate cut. It would have a wide-ranging impact on literally every citizen in this country, and increase buying power overnight. But there has not been a whiff of any such intent, and given the trauma engineered by its defective roll-out, I doubt any finance ministry official would want to inject fresh changes into a system that is yet to stabilize.
Whatever form a stimulus takes, its size would be limited by the fiscal constraint. India’s fiscal deficit is off course; equally worrying, it is difficult to get a precise fix on the number. The Centre’s declared fiscal deficit is now likely to be 4%, states will run up another 3%, and then there is “off-balance sheet" borrowing through public sector institutions like the Food Corporation of India.
JP Morgan’s chief India economist Sajjid Chinoy, now a member of the Prime Minister’s Economic Advisory Council, has estimated that the total borrowing needs of the government and its arms is 9% of GDP. That’s already a whopping amount, and it will be a brave budget that, firstly, admits to this being the correct number, and secondly, steps up and says it needs to be higher.
In my view, however, this is exactly what needs to be done. The time is now, with global liquidity still riding high. Yes, an expansionary budget runs the risk of a spike in bond yields, along with rupee depreciation. The latter is not a bad thing, though, as it might help our flagging exports. And if demand can be stoked, Indian corporations have shown the ability to access foreign funds.
Large corporations are able to raise funds via external commercial borrowings; smaller firms are able to sell equity to the scores of private equity and venture capital funds that have set up shop in India. And startups have found a thriving ecosystem of angel investors and platforms for raising capital. An exclusive focus on interest rates in the banking system should not deter the finance ministry from delivering a stirring stimulus to the system.
Yet, I don’t see it happening. The latest print of Consumer Price Index-based inflation, at 7.35%, is likely to be seen as a warning that large fiscal deficits will stoke inflation. Nothing scares Indian politicians like higher prices, and cautionary voices will restrain any call for stimulus.
I suspect the budget will be more of the same: optimistic GDP growth and revenue numbers, big targets for sale of public sector units, some tax cuts, and a promise of containing the fiscal deficit.
If this is how Budget 20 does turn out, we will have to look to other measures to flag growth, such as a massive bailout of the financial sector. In their absence, Indian asset prices will be dependent on the dominant wave in the global economy, which is cheap money, as long as it lasts.
This begs the question: if it is the US Federal Reserve and the European Central Bank that are driving asset prices, rather than domestic economic forces, why should I restrict my investment prospects to Indian assets?
The answer is clear: one shouldn’t. Top Indian equities are overpriced for the current level of growth, and there is a huge trust deficit with smaller firms. At a recent presentation I learnt that Bata India’s shares have a price-earnings ratio twice that of Nike, even though the latter’s sales are growing more rapidly than the Indian footwear firm.
Indian equities are priced for growth that they are not experiencing. This makes them a poor bet. In any case, it is a mistake for any investor to have all his assets in one geography. One of the better investing decisions I have made in recent times is to buy US equities, through exchange-traded funds focused on tech and other Nasdaq-listed companies.
Indian fixed-income products are increasingly unattractive with low yields, and the prospect of higher inflation makes their real returns extremely low.
There remains a strong case for gold. It is a valuable hedge against the sharp fall in the rupee, as also against geopolitical tension, which doesn’t look like ebbing any time soon. I’m not as bearish on the rupee as I was three months ago, partly because a slowing economy means lower demand for imports; also because I automatically buy the dollar when I buy US equities or gold.
And, yes, I continue to strongly subscribe to the support system for Indian startups. Talented young entrepreneurs can engineer non-linear growth even in a dull economy, by creating new products, services and business models. I hope Budget 20 displays transparency, boldness and a sharp focus on growth. If it disappoints, the case for diversifying one’s portfolio out of Indian assets, particularly equity, is urgent.