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A long bull run looks unlikely

The next 12 months are unlikely to bring better news for the Indian economy or the Indian stock market

A long bull run looks unlikely

For a year now, my colleagues and I have challenged the cosy consensus that the economy is recovering in India and the stock market is set for a long bull run. In my view, neither of these happy events is taking place nor are the next twelve months likely to bring better news for the Indian economy or the Indian stock market. So why does India find itself stuck between a rock and a hard place?

The Indian banking system will remain mired in pain for all of FY17 on the back of the two-fold problem it faces - the first related to new disbursals and the second to the existing assets. Over the past decade, around 90 per cent of India's capex has come from five sectors which have become synonymous with a murkier shade of capitalism - power and infra, metals and mining, telecom, oil and gas, and real estate. With the prime minister having severed the access that crony capitalists had to the political establishment in New Delhi, it is unlikely that crony capitalists will embark upon borrowing and spending exercises in FY17. Hence, it is hard to see the banking system growing out of its current woes. At best, I see system credit growth at around 12 per cent over FY17, FY18 and FY19. Further, as highlighted by the RBI deputy governor, S S Mundra, in his speech on February 11, while for PSU banks as a whole 17 per cent of their assets are stressed (i.e., NPAs plus restructured plus written-off), a staggering 32 per cent and 24 per cent of loans to medium and large corporates, respectively, are stressed. It seems inconceivable that in the current economic landscape and given how crony capitalists tend to behave, PSU banks will have any great success in recovering this money. Premised on such a bleak assumption, I believe that the shareholders' equity depletion of PSU banks will run into FY17.

Two developments over the past month, however, have given some hope to the ailing banking sector:

  1. The RBI has provided some relief on the definition of regulatory capital by relaxing rules on consideration of three balance-sheet items (revaluation reserves, foreign-currency translation reserve and deferred-tax assets) towards common equity tier I (CET1) capital, reducing the need for capital infusion into PSU banks by $4-5 billion.
  2. Vinod Rai, the highly respected former Controller and Auditor General (CAG) of India, has been appointed as the chairman of the Bank Board Bureau (BBB). Given his track record as the CAG, he is likely to drive administrative and operational changes in the banking system. That said, whilst these two steps are clearly in the positive direction, the core problem of PSU banks' re-capitalisation remained unaddressed (the Union Budget contained no new initiatives in this regard). Unless the finance ministry steps in with a credible banking recap plan, this will continue to remain an issue in FY17.

Apart from the banking-sector woes, the Indian economy also faces a challenge from the worsening liquidity situation in money markets. Under stress from rising NPAs on their balance sheets, banks have curtailed working capital finance to corporates, as a result of which the latter have turned to the commercial-paper (CP) market. This in turn has led to a spike in the three-month CP rates since the beginning of CY16 (the three-month CP rate has risen from 7 per cent to over 9 per cent in the first ten weeks of the year). In the coming days, the liquidity situation will also face additional pressure from the government's heavy borrowing programme (both on and off balance sheet) in FY17. According to the data from the Ministry of Finance, the government plans to borrow to the tune of ₹1.9 trillion ($28 billion or 1.2 per cent of the GDP) via issuance of quasi-sovereign bonds by public-sector enterprises like HUDCO and NHAI over FY17. Just to put this number into perspective, equity mutual funds in India have seen inflows of the order of ₹0.7 trillion in FY16 so far. Hence, even if 10-20 per cent of quasi-governmental bonds are subscribed by retail investors, there is likely to be a marked reduction in domestic equity inflows. In the absence of FII inflows to offset the reduction in DII flows, liquidity availability in the money market could be a big challenge.

So can legislative action provide a meaningful impetus to the Indian economy? Although the Aadhaar bill has been passed in the current session of the parliament, the bankruptcy bill has a 50 per cent chance at best of going through in this session, given the government's' reluctance to increase its own burden towards PSU banks' recapitalisation. The GST bill seems unlikely to go through in the current session of the parliament as the government and the opposition still don't see eye to eye on this bill; it being a constitutional amendment, the NDA does not have the numbers in the Upper House to get this bill through without opposition's support.

As far as the monetary policy is concerned, the Ambit Economics team's modelling process suggests that CPI inflation will average out at 5.5 per cent YoY in FY17, broadly in line with the RBI's projection of 5 per cent YoY inflation by end-FY17. However, given that there is a high possibility that the central government's fiscal deficit will exceed our initial expectation of 3.8 per cent of GDP, we expect rate cuts of the order of only 25-50 basis points for FY17. This is yet another area where the Ambit view is at odds with the glib consensus which seems to characterise the Indian stock market.

Saurabh Mukherjea is CEO - Institutional Equities at Ambit Capital and the author of Gurus of Chaos: Modern India's Money Masters.

This column appeared in the April 2016 Issue of Wealth Insight.