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A mid-year assessment shows that Indian equities could be close to the bottom
Good morning! A big hello to readers who signed up this week. Welcome to The Intersection, The Signal's weekend edition. This weekend we talk about the ongoing stock market uncertainty. Also in today’s edition: we have curated the best weekend reads for you.
When global media giants—Disney-Star and Viacom18—put down an eye-popping $6 billion to own rights to beam candyfloss cricket to viewers in a country that ranks 144th in the world on per capita income, it was a statement of expectations. When Sequoia Capital, one of the earliest backers of Apple and Google, raised $2 billion specifically to bet on Indian startups, it spoke to the entrepreneurial promise of a digital-savvy nation.
At first blush, it would seem like a new India story is shaping up, away from the general sentiment of gloom and doom globally. Christopher Wood, global head of equity strategy at Jefferies, describes India as the “best structural growth story in Asia and emerging markets for the next 10 to 15 years”.
Yet, as we write this, the NSE’s fifty-share index, the Nifty, fell through the technically important 15,600 level that analysts say could extend the index’s losses. Such technical support levels are akin to ledges on a cliff face. Breaking them means a slippery slope until the next foothold.
The slide betrays, in part, the rising anxiety that aggressive US Federal Reserve rate hikes could engineer a worldwide recession. Global inflation—fueled by choked supply chains that were already squeezed before Russia’s invasion of Ukraine—may be threatening India’s Covid-hit economic revival. High fuel and food costs are showing no signs of abating and the Reserve Bank of India seems poised to hit the trigger to shoot interest rates higher. That isn’t music to companies looking to expand their business in a fragile recovery.“Corporates are in a bind,” says Pronab Sen, former chief statistician of India and Country Director for the India Programme at the International Growth Centre. “They cannot entirely depend on the domestic economy and have to look outside for growth,” Sen tells The Intersection.
The capacity expansion plans of corporate India came to a sudden halt in March 2020 when the pandemic hit. All investments had to be put on hold. A year later when the recovery began, the big companies quickly completed interrupted projects. The smaller ones, however, could not recover. When demand increases, companies produce more by employing more workers and spending capital on fixed assets such as new plants, machinery and buildings. This sets off a virtuous cycle of growth and spreads general prosperity in the economy.
But the stop-start in expansion between pandemic lockdowns affected fresh annual addition of fixed assets. And the economic measure known as net fixed assets (NFA)—which are mostly new plants, machinery, buildings or similar assets set up by companies—grew by a mere 1.76% in 2020-21. It was 11.16% in the previous year, according to the Centre for Monitoring Indian Economy (CMIE).
Sen says corporates are now in a situation where they have a fair amount of capacity, but utilisation is sub-72%. Reports suggest that capacity utilisation may improve in the second half of the year. Confidence, however, has not returned to boardrooms.
"There is a close watch in boardrooms and corner offices on likely margin hits on account of cost inflation,” says Rama Bijapurkar, market strategy consultant and independent director. “Many companies across sectors seem understandably cautious and bearish at this time of so much uncertainty to let go of margins and punt on volume growth to offset it,” Bijapurkar tells The Intersection.
This swinging balance of hope and uncertainty appears to be the defining characteristic as we step on to the half-year threshold of 2022.
In September 2021, we’d highlighted the fissures developing in the Indian economy that weren’t reflecting in its cheap money-driven stock markets. Come October, the Nifty had hit an all-time high of 18,604. That’s when foreign institutional investors (FIIs) turned bearish and began selling Indian equities.
We wrote in January 2022 that historically, Indian stock markets had suffered a shock in the second year of every decade. At the time, the Nifty was hovering well above 18,000. But ever since, it has been downhill all the way. Between January 1 and May 31, FIIs sold equities worth a record $22 billion. The Nifty slid in tandem. And it is yet to hit the bottom.
This was in part because Indian markets were spooked by the US Fed’s anti-inflation rate hikes. The Fed did what it promised and then some more. The tech bubble blew, bringing grief to some of the world’s most celebrated managers of capital pools such as the ARK ETF, Softbank and Tiger Global. New asset classes such as cryptocurrencies and NFTs got walloped.
Interest rates have been rising in India too with the RBI raising its key rate to fight inflation. But while loans have become costlier, deposit rates have barely moved. That means retail money will likely continue to flow into equities, given there are few other avenues to invest.
While FIIs pulled away from equities, domestic institutions—their coffers overflowing with retail investors’ money—rushed in. Every month since September 2021 has seen inflows in excess of ₹10,000 crore into equity mutual funds. Value hunters such as insurance companies and the Employees’ Provident Fund Organisation (EPFO) have been shopping too. EPFO might pump in even more in the coming months as it seeks higher returns.
In its efforts to make a dent in the moribund jobs market (software services sector is the only bright spot), the government has promised to hire a million people in the next 18 months. Finance minister Nirmala Sitharaman had also committed a capital expenditure of over ₹7.5 lakh crore in her February Budget. Banks are ready to lend, having cleaned up their balance sheets. The economy, however, is still starved of big ticket private investment. Companies are reluctant.
“There is a very high level of uncertainty,” said the managing director of a finance company who is also a member of the boards of half a dozen large manufacturing and financial services companies. “We don’t know where we are headed,” he said, requesting that his name be withheld. That is no surprise. Indian businessmen are risk averse. The first real stock market boom of this century began in 2003 and lasted until 2008, during which the Nifty rose from just under 1,000 to over 5,000. But companies waited for a good two years before they started investing in fresh capacities. Net fixed assets grew from 4.73% in 2002-03 to just 5.48% in 2004-05. But next year, the growth rate leaped to 15.75%, according to CMIE. By that time the Nifty had crossed 4,000. It could well be that companies were utilising spare capacities when demand began to pick up, but they did not invest in new capacities early enough either.
“I have always said that it is not just our stock market that displays bullish and bearish behaviour,” strategy consultant Bijapurkar says. “Over time, we have seen India Inc also go through bullish and bearish phases when it comes to quest for revenue growth.”
Is It Time To Buy?
That’s hard to say. An end to the war in Europe could dramatically turn global sentiment. Former chief statistician Sen says much will depend on revival of demand. Medium and small companies are recovering, but not fast enough to push demand. But they are slowly getting there. That means the big firms’ pricing power will go away. “They had a free ride so far but as MSMEs recover, that is not going to be there,” Sen says.
That is perhaps one reason why conglomerates such as the Tata Group, Reliance Industries and Adani Group are on shopping sprees, buying up almost any company or business up for sale. Throughout the pandemic, Indian Hotels went about signing up new properties across the country. Such acquisitions not only expand their business footprint but also stall competition. Shareholders love the consolidation as it increases valuations.
Parts of the Indian economy are perking up. Jefferies’ strategist Wood highlights in his May 12 Greed and Fear journal that residential property sales rose 16% in the top seven cities. Home inventory dropped to a nine-year low.
Analysts at Kotak Institutional equities expect the 50 companies in the Nifty to collectively grow their net profits by 14% in FY23. In a June 1 note, they said that the index was earlier trading at a peak of 23 times the estimated net profit but had now dropped to about 19 times.
“We are passing through the eye of the storm,” believes the fund manager at a mid-size family office. “There will be some more pain before it gets better,” he says. The fund manager sees an uptick in capital expenditure. Announcements have been made. Billionaire Kumar Mangalam Birla’s AV Birla group, for instance, has declared that it would spend ₹82,000 crore over the next five years on new capacities, including a foray into paint making.
“Many companies are making capex announcements but there is nothing visible on the ground,” Mahesh Vyas, managing director and CEO of CMIE, tells The Intersection. The number for all companies for 2021-22 was not yet available but for listed companies it was just 2.1%, Vyas said.
According to the managing director quoted earlier, another subject of discussion in boardrooms is the emergence of smaller cities as hubs of activity. “Covid-19 has created a new India outside of the big cities for the first time. Places such as Coimbatore, Jaipur and Rajkot are booming,” he said. Many top tier companies are setting up offices in these towns, hiring locally and driving those economies.
Covid-19 has also triggered the reverse migration of several well-heeled big city dwellers to smaller towns. The new residents bring with them demand for high quality services and consumables. It helps lift the standard of living in those areas and fuels local entrepreneurship. Perhaps venture capitalists such as Sequoia will find the next crop of unicorns in these towns.
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