An uncertain beginning to the New Year

Despite short-term hit , demonetisation and GST are beneficial in the long run

Brexit and Trump’s triumph were low-probability outcomes until the voting day. The results gave voice to the powerful majority that was unheard before.

The central banks of ECB and Japan set policy rates below zero, which took over a third of the developed bonds to sub-zero levels. The fall in oil prices prompted OPEC and other oil producing nations to collectively agree on production cuts for the first time in eight years. Closer home, a decade-old effort to simplify indirect taxes found absolute consensus among all political parties to pass the GST Bill. The government was bold enough to get the long-standing Real Estate (Regulation & Development) and Insolvency and Bankruptcy Bills passed. It was bolder enough, in its continued effort to fight black money, to demonetise 86 per cent of the currency in circulation — which no country in the world did in the past.

What to expect globally?

Trump has three main items on the agenda — to cut corporate taxes from the current level of 35 per cent to 15 per cent; to spend $1 trillion on infrastructure and to facilitate companies to repatriate capital from abroad. As these measures are US-growth positive, the dollar index rallied to breach the 100 mark decisively, the 10-year US treasury pulled back 75 bps to breach the yield of 2.5 per cent, which was tested earlier, and the US equity indices have been touching new lifetime highs. The reality could be entirely different from expectations as Trump would have to build political equity for all the three agenda items.

China could continue to support investments in the economy through the quasi fiscal stimulus as it did last year. The weaker currency (depreciated 12 per cent in 17 months) would help in exports. The soft landing is a work in progress for China. The comments and actions of Trump on China have to be closely watched.

The Euro Zone will have a politically heavy year with a possibility that far-right parties could win in France and the Netherlands. As these parties initiate the process to exit the Euro Zone and the European Monetary Union, markets could correct globally.

World economic growth looks good with a strong US, a stable China and a stimulating Japan. The outflows from Emerging Markets (EM) may continue in the near term due to a strong USD. As valuations become attractive, the flows into EMs would reverse.

What to expect in India?

Due to demonetisation, consumption has suffered a setback for the next 2-3 quarters, impacting GDP to the tune of 100-150 bps in H2-FY17. Based on dependence on cash transactions and operating leverage, different sectors would be impacted in varying proportions.

Some export-oriented sectors or the ones in B2B segment are not affected at all. Just to quantify, among the Nifty companies, 43 per cent (by weight) of companies in sectors like IT, pharma, oil and gas and power are not impacted. 53 per cent of companies in FMCG, autos, financials, etc., may be impacted for less than two quarters. Only 4 per cent of companies in cement and paints may see an impact for more than two quarters.

Following the effect of demonetisation will be the implementation of Goods and Services Tax (GST). Businesses have to further readjust to the new indirect regime resulting in de-stocking and change in current operations.

Though we see impact on growth in the short term, both demonetisation and GST are immensely beneficial in the long run. The tax net would widen, tax compliance would improve, more banking services would be accessed and more businesses move into the organised segment.

Development is not only an economic necessity but also a political one. Cutting direct taxes, subsidised housing, rural development and building infrastructure could be the key focus areas for the government.

In the next two to three quarters, macro data and companies’ results could be volatile. However, as things stabilise in H2-FY18, earnings could recover. We expect the earnings of Nifty companies to grow at 19 per cent in FY18 led by financials and autos.

The year 2017 will see lower bond yields and fixed deposit rates. It will see falling real estate and gold prices. It is equities that is providing a good alternative for investment with a medium-term horizon. The valuations are reasonable and the base for sustained earnings growth is being set up.

The writer is Co-Chief Investment Officer, Birla Sun Life Asset Management Company

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