Vijay Kumar Gaba

The GDP data for 3QFY21 and second advance estimates for FY21, released by CSO last Friday has evoked mixed response from economists. While the positive growth number (0.4%) for 3QFY21 has been received with a sigh of relief (as it ends the technical recession), the downgrade of full year FY21 estimates from -7.5% to -8%, implies a negative growth print for 4QFY21. Presently, growth estimates for 4QFY21 range between -0.8% to -1.5%.

The slowing momentum in 4QFY21 has also resulted in changes in FY22 growth estimates; which now mostly range between 10-11%. This implies a normalized growth of about 1% CAGR over FY21-FY22.

I have highlighted this issue earlier also. For common man nominal GDP is more important because lot of variables like effective taxation, budgetary allocations for development and social welfare, subsidies, salaries of public servants, etc. are calculated as a factor of the nominal GDP. Lower nominal GDP essentially means lower income for people and lower tax revenue for the government.

For example, the sharper fall in nominal GDP has resulted in sharper rise in effective rate of indirect taxes; which impacts the common people more, resulting in increase in income inequality and social injustice

In my view, the fall in nominal GDP over past 7-8years has been more worrisome than the real GDP. The nominal GDP growth rate has almost halved during FYFY13 and FY20. One of the better part of FY21 GDP estimates is that the decline in nominal GDP seems to have been arrested. With larger inflation tolerance range of RBI, hopefully this trend might get reversed in due course.

Insofar as the enthusiasm over positive GDP growth print is concerned, I would like to highlight the concerns raised by Dr. Pranab Sen, former Chairman of Indian Statistical Commission. As per Dr. Sen-

·         Recent GDP data is indicative of the slowing growth momentum and suggests that Q4 is not going to be great.

·         Investments (Gross capital Formation) is worrying for FY22 also.

·         Negative growth in 3QFY21 in Public Services is a source of worry, as it highlights resource constraints for the government.

·         The government expenditure that contributed significantly to the GDP growth numbers, includes significant amount of repayments of past dues. The growth in actual expenditure on real goods and services or creation of demand is not significant.

On the positive side, the growth in construction and manufacturing sector is encouraging; while agriculture growth stays strong. Given the expected record Rabi crop this season, the agriculture growth is expected to stay strong in 4QFY21 also. This gives hope that the normalized GDP growth may return to pre Covid level (FY19) in FY23-FY24.

It is however pertinent to note that pre Covid growth rate was quite dismal, in all respects. Moreover, we may not achieve the 6% long term growth (5yr CAGR) trajectory for till FY25 at least.

The latest earnings season has started on a very buoyant note, led by some IT companies. In line with the high speed macro indicators, most brokerages have upgraded their earnings estimates in past one month. The present estimates are building in a very strong earnings recovery over FY22-FY23. The estimates for the current year FY21 have also been upgraded sharply from a contraction of 5% to 12% to a growth of 5% to 12%. Currently, the market is estimating an earnings growth of 24% to 38% in FY22 and another 18% to 22% growth in FY23.

It is important to note that these estimates assume GDP growth of -7% to -7.5% in FY21; 9% to10% in FY22 and 4 to 5.5% in FY23; interest rate bottoming in FY21 and elevated inflation of 5 to 6% over FY22 and FY23.

This implies less than 3% CAGR of GDP over three year period of FY20-FY23. Whereas, the present estimates imply ~19% CAGR in Nifty EPS over FY20-FY23. Apparently, there is disconnect between the macro forecast and earnings forecast. In past two decades at least, there is no precedence of such strong earnings growth with a dismal economic growth.

Furthermore, the estimates assume a strong recovery in earnings of financials and materials, from a very low base. Just to give a sense, Kotak Institutional Research estimates 473% (yoy) growth in Banks PAT and 860% rise in Metal’s PAT in Q3FY21. Construction Material (86%) is the third fastest growth forecasted. These three sectors probably have the strongest correlation with the macroeconomic growth and stability. Next 9months may be a case of low base effect, but with 3% economic growth, higher interest and inflation, it is tough to fathom these sector continue clocking sustainable high growth.

So in all likelihood the earnings estimates for FY22 and FY23 will fall in due course, as has been the case historically. Credit Suisse highlighted in one of their December report that EPS estimates fall 10 to35% from the level that is first estimated.

In my view, therefore, it would not be advisable to consider aggregate earnings as a key factor for investment decision. Better would be focus on the companies where sustainable earning growth visibility is very high. Of course these stocks will also fall in case of a broader market correction, but the chances of their bounce back would be much higher.

I shall therefore remain agnostic to sectors and size of companies. I would rather focus on individual companies for investment. Sustainability of growth would be my key consideration in selecting the company.