Technical Analysis

Investors to shift focus to fundamentals

| Updated on May 26, 2019 Published on May 26, 2019

Improved sentiment of single-party rule to augur well for FII flows and mutual funds

With the 2019 general elections, India has ushered an era of stable single-party rule. The victory of the BJP and the NDA indicates that 2014 win was not a one-off and that, possibly, the era of coalition politics (1989-2014) has come to an end.

Traditionally, a party with dominance in the North, West and central India, the BJP has gained a foothold in the East — West Bengal, North-East and Odisha are States where it has fetched more seats than in 2014. However, the party is yet to boost its presence in the South, barring Karnataka and, to some extent, Telangana. The mandate 2019 bolsters optimisms of stability, decisive leadership, and continuity in governance, reforms and policy agenda. Policy predictability will go up.

Single-party majority will continue to facilitate decision-making and structural reforms. Improved sentiment, post the formation of a stable government, will augur well for foreign institutional flows and domestic mutual fund inflows, which have seen consistent scale-up in systematic investment plan (SIP)-based investments.

Highlights of Modi 1.0 regime

One of the key achievements of Modi 1.0 regime was reining in inflation and fiscal consolidation.

Getting these two under control has clearly improved the attractiveness of the India story.

A host of structural economic reforms — GST, IBC, RERA, Monetary Policy Committee (MPC), demonetisation direct benefit transfer (DBT) — were implemented by the NDA in the previous term. Infrastructure creation received emphasis and road construction doubled during the five years.

The Modi 1.0 regime will also be characterised by the comprehensive clean-up of the banking system with excesses of the past being recognised and provided for. This should pave the way for emergence of the new credit cycle. The government also targeted improvement in rankings in ease of doing business and improved the rank. It pushed the social welfare agenda through its flagship schemes such as PMAY, Ujjwala, Swacch Bharat, Ayushman Bharat, Saubhagya, PM Kisan and Mudra. DBT helped plug leakages in government subsidy transfer to beneficiaries and has created a new paradigm for subsidy transfers.

The larger economic reforms and social welfare agenda are likely to continue, with renewed emphasis on infrastructure development (roads, housing and waterways). In Modi 2.0, the economy and markets will have a relatively smooth trajectory, sans any disruptive and transformational macro reforms.

Immediate concerns

From the near-term perspective, the immediate focus of the government would be to revive the rural consumption engine, address the liquidity issues of NBFC/debt markets in coordination with the RBI, and drive fiscal spending to revive industrial growth (IIP growth has moderated significantly over the last two months).

Real interest rates in the economy remain high, despite inflation being largely in control and within the target band of the RBI. The next RBI policy in June and the first budget of the new administration in July 2019 will be the key policy events to watch out for.

With politics behind, the market’s focus is expected to revert to fundamentals and corporate earnings. The Modi 1.0 regime saw corporate earnings growing at a sub-optimal rate, given the backdrop of structural and disruptive macro reforms.

India’s corporate profit to GDP ratio has moderated from 5.5 per cent in 2008 to 2.8 per cent in 2018. However, the corporate earnings cycle appears to be bottoming out, and with a revival in credit growth and asset quality of corporate banks, FY20 looks poised for the first year of healthy 15 per cent plus earnings growth.

However, there may be much room for significant re-rating for the markets, given the underlying fair valuations (19.5x FY20E Nifty EPS) and continued earnings downgrades.

 

Motilal Oswal

The writer is CMD, Motilal Oswal Financial Services

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