The brokerage firm, Sanford C. Bernstein in a recent report highlighted some noteworthy points. The firm evaluated whether the recent sharp fall in economic growth would mark the end of the slow growth cycle triggered by the global financial crisis a decade ago; and beginning of a sustained high growth cycle leading to a multiyear bull market in Indian equities.
The issue is relevant from many points. But as an investor, I find it more pertinent in view of the current market sentiment. The huge divergence between the macroeconomic data and equity markets has disturbed even seasoned investors. The common investors on the other hand are swinging wildly between the opposite polls of greed and fear. Each one percent rise in equity prices ignites the greed and slight fall in prices imposes the fear. Obviously, swaying by these extreme emotions, not many investors/traders are able to maintain their composure and losing money. The rising volatility in the prices of precious metals is making the situation worse, as many investors are getting avoidably distracted by this.
The cited report highlights that the previous strong macro cycle in India was during FY04-10; after making a low in FY01-03 period.
The present macroeconomic conditions resemble the lows of FY01-03 in many aspects. The socio-economic redundancies caused by the radical reforms initiated in 1991-1995 period led to massive buildup in bank non-performing assets and unemployment. The asset prices were also collapsing. The people rejected the extant political regime and lack of an alternative led to 3 general elections in 3years (1996-1999). To make the matter worse we had consecutive poor monsoons in 1999-2002, leading the rural economy in a poor state.
The capacities build post 1991 and a second set of radical reforms during 1991-2003, finally started yielding results from 2004. Strict fiscal discipline, controlled inflation, falling interest rates, rise in household savings, and rising exports helped the economy to revive. The global recovery leading to resurgence in services exports was a key factor in the economic recovery as it created unprecedented wealth effect in the Indian middle class. Demand for automobile, housing, commercial real estate etc had an immense positive impact due to developments in IT sector, construction of highways and SEZs.
The commitment to reform was very high. The government did not hesitate in divesting number of monopolies like coal, power, oil & gas, civil aviation, mobile telephoney, roads, ports, airports, etc. The best part was the execution of reforms. Many PSUs were disinvested, with ministers not hesitating a bit on potential corruption allegations. MNREGA cemented these macro reforms by transmitting the benefits to the bottom of the pyramid.
The cited report, rightly highlights that the execution on reforms by the current regime is not inspiring. "With lower returns, limited access to resources, private sector is not keen to participate in Infra and the easier Infra catch-up build is already behind. Smart cities, mass transport systems are new scripts, but execution is weak and volatile. Inability to scale-up manufacturing and focus of Indian companies on traditional products makes it difficult for exports to scale-up meaningfully."
Moreover, the household savings are declining structurally and leverage rising. The geopolitical considerations mean that the subsidies from China, in the form of cheaper imports may also be not available. The exports which supported the previous up cycle in Indian economy and markets are not likely to see any quantum jump in short to midterm. Import substitution is a tricky business and impacts the competitiveness of Indian businesses in the short term.
The report concludes that "the new scripts are interesting, can help create some jobs, but are not game changers – we expect a rebound in macro in 2HFY21/ FY22 but currently see less room for a multiyear bull macro cycle."
I mostly agree with the prognosis.
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