Despite the recent market rally, I’m bullish on Indian equities – especially domestic economy plays. Before I come to what to expect from the next government, some key assumptions:
(1) A moderately stable (if not strong) coalition governmentin May, wherein the anchor national party will have at least three-four key regional parties (plus other smaller parties) to choose from if any one doesn’t play ball.
(2) A benign global economic and liquidity environment – the US is likely to continue its gradual recovery, along with steady US Federal Reserve quantitative easing tapering, which will result in gradually higher US bond yields. The European Central Bank is worried about deflation and a stubbornly strong euro, so will be in easing mode – and Japan already is. China’s growth will slow down but we won’t see a hard landing (at least not this year).
(3) No spike in commodity prices, given the weak Chinese demand (in particular, oil supply/inventory likely to keep oil prices subdued) and rupee to be largely stable – given a weakening trend in the renminbi and the Reserve Bank of India’s low tolerance for the rupee appreciation.
(4) Favourable investor positioning – the outlook for most big emerging markets (Brazil, China, Russia, excluding Indonesia) – remains weak, so India should continue to get a disproportionate share of the emerging market funds’ equity flows, given our relatively better economy.
It’s wrong to think foreign institutional investor flows (FII) this year have come in largely on election hopes – on the contrary, many large FIIs find it difficult to justify making bets on political forecasts (which went wrong in 2004 and 2009). India-dedicated FIIs or our local equity funds still haven’t seen meaningful inflows as yet. In India, retail equity ownership is very low and now the prospects for fixed income/gold/real estate aren’t as attractive as even a year ago (with RBI unlikely to cut rates in a hurry as inflation is still high). And, while there has been a recent rally in cyclicals/mid-caps, this is off a low base and most FIIs/domestic institutional investors (DII) are still positioned in “quality” large-caps.
Here’s my list of five things we should expect from a new government in its first year (with upside surprises if there’s a strong one):
(i) We’re unlikely to see big cuts in oil, food or fertiliser subsidies or sharp tax increases or more aggressive divestments – gradual, steps are likely so expect only a gradual reduction in the fiscal deficit.
(ii) We’re unlikely to see a big recapitalisation of public sector banks or government holding falling below 51 per cent or forced bank mergers – instead, expect a greater crackdown on wilful defaulters and focus on non-performing loan recovery, so overall bank credit growth will remain constrained with private banks continuing to gain market share.
(iii) Stalled power projects and coal/iron ore mining will be revived via faster clearances, and better co-ordination with state/local governments. Expect railway constraints to worsen in the short term, so the commercial vehicle sector and north India cement players should benefit.
(iv) Greater investments in railways, especially in the Delhi-Mumbai Industrial Corridor and other such industrial corridors.
(v) Big focus on power transmission & distribution and renewable energy.
Many other things can happen but the five trends mentioned above are my views. Main risk is of a weak and fragmented political outcome, which would kill investor sentiment in the short term and we would run the risk of getting into a vicious cycle. But I see that as a very low-probability event and by not investing in domestic economy plays, you’re risking your portfolio on such an adverse event materialising and missing out on the investment opportunity now.