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If Jaitley Does This, Market Correction Will Be Inevitable

Jan 27, 2017

In this issue:
» Government's biggest welfare spending
» Moody's subtle warning on government's debt problem
» Why we were not optimistic on BSE's IPO
» ...and more!
00:00
Tanushree Banerjee, Co-Head of Research

History is replete with leaders taking extreme measures to counter economic disaster. Especially after famine. Most resorted to pardoning taxes. Others built monuments to create jobs.

British economist John Maynard Keynes supported this form of government largesse...

The government should pay people to dig holes in the ground and then fill them up.

Such programs have become the hallmark of governments the world over. The subprime crisis gave governments in the West the excuse to print money endlessly. China's resolve to create jobs led them to build buildings, bridges, and whole cities they didn't even need. And in India, no government budget has been complete without subsidies.

We doubt the Union Budget 2017-18 will depart from history. So we must warn you that these Keynesian policies could ruin the chances of an earnings recovery.

Now, we believe demonetisation has deferred, not destroyed, the upside in the earnings trajectory. And for the best businesses in India, demonetisation could actually be an opportunity in disguise. Indeed, most companies we've met with are confident the pain of notebandi will subside in a few quarters. Even a slight demand revival could provide a powerful windfall for many stocks.

So we hope the Budget does not warrant a 180-degree change in our view.

Subsidies are not the only populist policies in the Budget that worry us. Schemes like the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) could be equally damaging. The outlay under this scheme could touch a record of Rs 580 billion this fiscal. Even after accounting for spillovers, this is the highest spend under the program since its inception.

To keep schemes like MGNREGS going, the government will have to wade into the credit market. It will have to binge-borrow and suck up liquidity. It could force the heavyweight public sector banks to subscribe to its bonds. And it could crowd out the private sector by making the cost of credit too high.

Private sector investments are already at decade lows. Further resistance to borrow could choke the flow of credit in the banking system.

Housing credit and retail borrowing by people like you and me can only add a speck of optimism. In the absence of demand for credit from corporates, the earnings revival is not turning.

So the Budget could either offer the private sector better reasons to set up new businesses and grow existing ones. This could include making it easier to do business, providing a more conducive tax structure.

Or it could continue to find ways to spend taxpayer money on schemes that have minimal impact on real GDP.

If you ask me, the pressure to ease the notebandi pain will weigh heavily on the Budget this time. So it will not be without the usual generous dose of sops.

But reviving private sector demand and spending is more critical than ever before. Our assumptions for earnings estimates will hinge on this. And we will not hesitate to warn you if the earnings recovery seems like a distant possibility.

Mind you, the rise in stock prices through most of 2016 came on the back of expectations of recovery in corporate earnings. The actual recovery is yet to become clearly visible. And if this visibility fades, so will the valuations of expensive stocks. A sharp correction in the markets will then become inevitable.

On a related note, I just recommended a business that has successfully hedged its earnings against domestic economic woes. That makes the safe stock less vulnerable to market corrections.

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03:20 Chart of the Day

As reported in Mint, the current annual budget for government's social programmes for rural India is around Rs 2.5-3 trillion. Budgets have had a historical trend of rising allocation for rural welfare. At the same time it will have to fetch enough revenue so the expenditure does not come through additional debt.

Will the Government Continue to Oblige?


03:45

Just prior to demonetisation, global rating agency Moody's affirmed India's 'Baa3' ratings. Let us remind you, India's current Baa3 rating implies lowest investment grade. It is just a notch above 'junk' status. High debt to GDP ratio tends to dampen the credit worthiness of the Indian economy. This risk is worrying because any slip up could impact the country's rating.

Now Moody's has come back with the warning that the government has limited fiscal headroom. India's debt-to-GDP ratio currently stands at 68.6% and is high as compared to peers. Whether the government is able to stoke growth while capping its debt burden will be critical to our ratings.

04:10

BSE Limited, India's oldest stock exchange is all set to get listed on the NSE. The IPO of BSE received an overwhelming response. The offer was subscribed by over 50 times.

Coming to our view on the offering, we were not too impressed with the cash based valuation that the investment bankers justified. Apart from the uncertainty about usage of the excessive cash on books, the poor margins and return ratios were a worry.

Madhu Gupta, our in-house expert on stocks belonging to banking and financial sectors, laid out her rationale for avoiding the IPO (subscription required) clearly....

Here is an abstract from the IPO note.

  • Growth in the exchange's bread and butter, securities services, continues to stagnate with only the listing business providing some comfort on the back of robust primary market in last two years. But such an income stream cannot be consistently sustainable. Moreover 29% of its revenues comes from non-core investment income that lends further volatility to its business.

Further,

  • BSE's valuations at 36 times TTM earnings appear quite stretched even when compared to global indices such as Nasdaq and NYSE. We have not considered the huge cash and investments of Rs 38.6 trillion on the balance sheet. We like to be conservative and given the lack of clarity on how the exchange's huge cash hoard will be profitably employed in new venture

Over and above,

  • BSE's growth in the core business of equity cash and derivatives remains muted, we would like to wait for more clarity and sustainability in its business dynamics for the investment to become value accretive.

Incidentally, an article on Business Standard lists the historical performance of the global exchanges. Most of them have fared poorly on growth and margins to say the least. The average growth of last five years for most of the indices have been disappointing. For instance, Nasdaq profits have grown by 6.9% while for Australian exchange the same was up by 2.7%, in the last five years. There are others like Deutsche Boerse AG that have shown decline in profits growth.

04:40

In the meanwhile, after opening the day in the green, the Indian share markets have continued to trade strong and are currently trading above the dotted line. With the exception of stocks in the FMCG sector all sectoral indices are trading on a positive note. Stocks in the Power sector and the banking sector are leading the gains. At the time of writing BSE Sensex was trading up 181 points (up 0.7%) and the NSE Nifty was trading 42 points (up 0.5%). Meanwhile, the BSE Mid Cap index is trading up by 0.8%, while the BSE Small Cap index is trading up by 0.7%.

04:50 Investing mantra

"Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst) and Bhavita Nagrani (Research Analyst).

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Equitymaster requests your view! Post a comment on "If Jaitley Does This, Market Correction Will Be Inevitable". Click here!

3 Responses to "If Jaitley Does This, Market Correction Will Be Inevitable"

Mohmed

Jan 30, 2017

That means a comment will not appear unless it is anti BJP and anti PM and supporting the corrupt like duffer Sonia and others.

Like 

Mohmed

Jan 30, 2017

That means a comment will not appear unless it is anti BJP and anti PM and supporting the corrupt like duffer Sonia and others.

Like 

KD

Jan 28, 2017

So what. aaaaa a aaaaa will increase price of diesel and Petrol to ₹100.

Like 
  
Equitymaster requests your view! Post a comment on "If Jaitley Does This, Market Correction Will Be Inevitable". Click here!
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