Vijay Kumar Gaba

From top economists, analysts, and global strategists to a common man on the street, all are worried about an imminent US default and its impact on the global financial system, especially the developing and underdeveloped countries.

Currently, the US public debt is close to US$35trn (Appx 125% of annual GDP) and is projected to double in the next eight years. The current US government's annual interest payments are more than US$1trn (Appx 20% of annual federal revenue; 14% of annual federal spending and 4% of GDP). The average interest rate on the entire debt is less than 3% p.a.

As of June 2023, 43% of this debt was owned by the Federal Reserve System and State and Local Governments. 32% of the debt was owned by various domestic institutions (MF, Insurance, Pension, and Depositories, etc.) The balance 26% was owned by other institutions including foreign governments. Almost the entire debt is denominated in USD.

This debt level is a matter of concern but does not prima facie appear to be at a disaster level. The worrisome part is that about one-third of US public debt is short-term (12 months or less maturity). However, considering that a large part of this debt could be owned by the government institution and the Federal Reserve System, refinancing of this debt should not pose a significant problem. In my view, US debt could be sustained with 3-4% inflation, 20% USD devaluation, 5% revenue growth (higher taxes), and rationalization/reimbursement of various war funding expenses, this debt could be sustained, reduced, and serviced. It is of course going to be hard for US savers and middle classes for a decade or so. USD losing its reserve currency status may be collateral damage.

For context, as per the interim budget for FY25, India’s central government debt was ~Rs172trn as of 31^st March 2024. This is approximately 58% of GDP. 3% of this debt is held by foreign entities. However, using the standard IMF definition India’s Debt to GDP ratio is ~82%. Since most of this debt is INR-denominated and RBI is holding a strong US$650bn forex chest, servicing is not an issue.

However, as per FY24BE, interest expense would account for 25% of total government expenditure, after material cuts in subsidies. For a developing economy, this interest expense to government revenue expenditure is considered worrisome, as it hampers investments, keeps fiscal deficit high, makes interest rate cuts difficult, leads to lower social expenditure affecting the quality of life, and hampers further market borrowing capability of the government.

The small point is that investors in Indian securities should be more concerned about seemingly unsustainable public debt in India rather than the high debt levels of developed countries.

As a small investor with zero risk appetite, I keep a cushion for lower subsidies, late payments of government dues, higher effective taxes, small probability of higher rates in my investment strategy.

Stock markets – Capex theme finally catches up

The Benchmark Nifty50 has gained ~18.5% YTD2023. But the heightened action was witnessed in the broader markets where Nifty smallcap100 gained ~53% and Nifty Midcap100 gained ~45%, sharply outperforming the benchmark. The overall market capitalization of NSE increased ~26.6% to Rs355 trillion (US$4.28trn).

The investment theme - capital goods, infrastructure, construction, and manufacturing were the top themes in 2023. Defense, clean energy, Real Estate, power, roads, railways, etc. - did exceedingly well. The materials (metals, cement, etc.); large private banks, services, and consumer finance were relative underperformers.

·         Realty, Defense & Railways PSEs, PSU lenders, Power, and Clean Energy were the top themes for 2023.

·         International equity funds and Gold ETFs were the worst-performing fund categories; smallcap funds were the remarkable outperformers.

·         Most large cap funds managed to beat the benchmark Nifty50 by a decent margin.

·         The valuation gap between broader markets and Nifty widened to 2018 levels when a sharp correction was witnessed in broader markets.

·         Long-term (5yr rolling CAGR) Nifty returns are in double-digit for the unprecedented fourth year.

Earnings growth – all set for a sustained up move

Nifty EPS is all set to record a fourth consecutive year of double-digit growth in FY24. The earnings in the five years FY20-FY24e have grown at 14.4% CAGR. The outlook for FY25 and FY26 is also promising with consensus estimates suggesting over 15% CAGR over FY25-FY26.

Flows positive – Quality of domestic flows remain good

The overall institutional flows in the secondary markets remained positive consistently. Over all, FPIs pumped in over Rs 1.12 trillion (YTD 2023) in Indian equities; while domestic institutions were buyer to the tune of Rs1.74trn. The best part was the quality of flows. The entire Rs1.7trn of domestic new flows was through SIP route and hence sustainable and stable.

Debt and currency – bonds stable amidst global turmoil; INR marginally lower

Indian debt and currency markets were perhaps the most stable among the global emerging market and developed market peers. While the sovereign ratings of countries like the US and China witnessed adverse rating action, India’s sovereign rating remained stable with a case for upgrade. The benchmark yields ended lower for the year despite tighter liquidity and higher policy rates. During the year INR was down ~5% against USD and ~9% against EUR.

As the yields were mostly stable and the yield curve flattened, duration did not affect the bond returns. Most debt funds (including Liquid) on average yielded 6-6.5% return.

The year 2023 has not been good for commodities. With the global central bankers determined to reign inflation with aggressive, monetary tightening, demand slowing, and post-Covid logistic challenges easing materially, most commodities yielded negative returns in 2023. Natural gas, agri commodities (wheat & corn) crude oil, and base metals were notable losers.

·         Precious metals managed to stay in positive territory but did not yield any return despite having all the reasons to do that.

·         Energy prices have corrected back to the pre-covid period. Natural Gas and Crude Oil (despite higher production cuts by OPEC+) ended sharply lower. Natural gas prices are now lowest in three years. The latest inventory, consumption, and production forecasts for 2024 and 2025 are indicating further easing in energy prices over the next couple of years.

·        Agri commodities corrected despite inclement weather conditions across geographies and continued hostilities in Ukraine and sanctions on Russia.

  Cryptos – Gaining wider acceptance

Cryptocurrencies have been the best performing asset for the year. Value of Bitcoin, the largest and most popular cryptocurrency, has gained ~250% during 2023. Cryptocurrencies continued to gain wider acceptance from governments, regulators, financial institutions, market participants, and investors. Several smaller African and Latin American countries, like the Central African Republic, Uganda, Zimbabwe, El Salvadore, Paraguay, Venezuela, etc. have adopted cryptocurrencies in their monetary system, some even declaring bitcoin as legal tender.

Economic Growth – India best in the class

The overall economic growth is moderate as two of the primary engines of global growth the US and China stuttered. Germany and Sweden flirted with recession for most of the year, while the UK, France, and other European countries barely grew. In Latin America, Brazil managed to grow its economy by 3%, Argentina, and Chile were in recession, and other economies barely grew. The leading commodity-producing economies in Middle East Asia, Africa, and the Pacific (Australia) were either stagnant or contracted.

India - Best in the class

1HFY24 GDP growth (7.7% yoy) has surprised on the upside, beating the RBI estimates (6.8%) by a fairly wide margin. Most agencies and analysts have upgraded their growth forecasts for the entire financial year FY24 by 20-50bps. RBI had earlier estimated FY24 GDP growth to be 6.5%; but the current trajectory is indicating that India’s GDP may record 7% growth in the current year. The growth momentum also indicates that the present rates may not be restrictive for growth.