Vijay Kumar Gaba

After FY09, the current financial year (FY21) has been the most eventful year in most respects – social, economic, financial, ecological, science, and geopolitical.

Socio-economic disaster: The spread of SARS-CoV-2 (Covid-19) virus that started sometime in last quarter of 2019 was declared a global pandemic in March 2020. The pandemic engulfed the entire world in no time, causing tremendous loss to human life and global economy. The mobility of people was restricted in most countries substantially. The economic activities were also curtailed only to the “essential” activities. Consequently, the global economy faced a technical global recession as most major economies recorded negative growth during 1HFY21.

The pandemic this had disastrous socio-economic consequences. Millions of jobs were lost and workers displaced; smaller businesses which could not bear the cost of lockdown faced closure or were further scaled down; loss of lives traumatized families; and millions of poor children who could not afford cost technology access were rendered out of schools. The inequalities rose sharply, further widening the social, economic and technology divide that has been hindering the global growth since the global financial crisis (GFC, 2008-09). It is estimated that millions of families across Latin America, Eastern Europe, Asia, Africa, and Indian subcontinent, that were brought out of poverty in past couple of decades face the specter of slipping back into the abyss.

Financial profligacy of gargantuan proportion: The pandemic and consequent economic lockdowns evoked unprecedented response from governments and central bankers across the world. The amount of fiscal and monetary stimulus created is unprecedented; even much higher than the quantitative easing done post GFC. This has certainly put question marks over sustainability of global debt (over $15trn still yielding negative return); ability of governments to support the poverty alleviation efforts.

Ecological awareness: One of the positive outcomes of the pandemic has been the rise in awareness about the ecological conservation. The partial lockdown of commercial activities demonstrated how the mother nature could heal itself within few weeks. The urban population which was moving away from the nature was reconnected with roots. This awareness may certainly accelerate the execution of global climate change action plans, saving the planet from imminent disaster.

Scientific advancement: The pandemic prompted a vaccine development program at unprecedented scale and speed. The scientists world over worked to develop an effective vaccine for the SARS-CoV-2 infection in no time. Never in the human history an effective antidote to a potent virus has been developed at such alarming speed. It is estimated that in next 3-5years the entire global population could be inoculated against this virus. The experience gained in development and administration of Covid-19 vaccine may be extremely useful in fast tracking the efforts for development of vaccines for other major infections like HIV and H1N1 etc. It shall also help in eradicating or controlling many deadly diseases in African continent, thus bringing the most endowed and most poor continent in the global economic mainstream.

Trade and Geopolitical tension: An intense trade war between the two major trade partners, viz., USA and China, had started couple of years ago. Besides, trade tensions were also rising between China-Japan, India and China and US and EU. The conspiracy theories behind origination of SARS-CoV-2 virus from Wuhan province of China, further deteriorated the trade conflicts into geopolitical tension. Some major economies and global corporations decided to reduce their dependence on imports from China; and use of Chinese technological firm’s services and equipment. India and China also had a material buildup at Northern borders. China intensified the efforts to build strategic block with allies like Iran, Sri Lanka, Pakistan, North Korea etc. These developments shall have a far reaching impact on the global economic and geopolitical situation. The full impact of this may be known in next decade or so only.

Indian markets

The initial reaction of Indian markets to the pandemic was that of panic. The prices of equities and bonds crashed precipitously. The panic however subsided soon as the government took some strong measures to control the spread and mitigate the damage due to economic slowdown. The FY21 journey of Indian markets could be summarized as follows:

Nifty rallied hard, catching the participants by surprise

Nifty is ending FY21 (all Nifty data till 29 March 2021) about 20% higher than its December 2019 closing level. Nifty rallied hard in October –December 2020 quarter as the unlock exercise started and earnings upgrade cycle kicked in. By November 2020 all Covid-19 related losses were erased.

The strong market rally in fact caught many participants by surprise as the divergences from the real economy became too evident. The rally was apparently supported by the fact that the large organized players have not only survived the lockdown well but gained material market share from the smaller unorganized players. Multiple stimulus packages announced by the government and consequent abundant liquidity also have helped the rally.

The rally however appears to have tired in 4QFY21, for lack of triggers.

India with over 75% (Nifty TRI) gains is the second best market (after South Korea 78%) amongst all global major markets. It outperformed peers like Brazil (21%), China (25%), and Indonesia (40%); and developed markets like UK (21%), US (48%), France (37%) and Europe (36%), .

The momentum however has slowed down considerably in 4QFY21. In the current quarter, India (up 4%) is sharply underperforming US (8%), Japan (7%). Germany (8%). Even though it is still outperforming its emerging market peers like Brazil, China, Indonesia etc.

Consumption lags, cyclicals, IT & Pharma shine, smallcap outperform; FPIs’ big buyer

Metals, IT, Auto, Realty and Pharma have been the top performing sectors in FY21. Consumers have underperformed massively. Financials performed in line with the benchmark indices.

Broader markets (small and midcaps) and Alpha strategies sharply outperformed the benchmark indices. The market breadth has been mostly good (8 out of 12 months).

Net institutional flows were not great (less than $9trn) considering the abundance of liquidity and lower rates. FPIs though poured over $27bn in secondary equity market alone.

Gold disappointed; broader markets underperform on 3yr basis

Despite the huge rally in benchmark indices and broader markets, the household investors continue to be disappointed. One of their favorite asset class ‘gold” has underperformed majorly. Intuitively, gold ought to have done well in a crisis marred year. Gold ETFs have returned almost nothing in FY21 and are down over 10% in the current quarter.

Mid and small cap stocks have given superlative return in FY21. However, if we account for the massive underperformance of preceding two financial years, the performance of broader markets continues to remain below par.

Debt market jittery about large borrowing program

The government has managed the FY21 borrowing program well without any noticeable damage to bond markets or private credit. The bond market returns for FY21 have therefore been more than decent. However, in past 3months, rising global yields and huge Rs12trn borrowing for FY22 has kept the debt market on the tenterhook. A steeper yield curve due to abundant liquidity and RBI’s efforts has further queered the pitch for bond investors.

The Reserve Bank of India managed the markets well. It avoided direct monetisation of government borrowings and supported the government borrowing by all means available to it. At end of the day, RBI may close FY21 with a ballooned balance sheet equal to the size of 30% of GDP.

INR recovers from panic fall, stable around Rs73/USD

On announcement of lockdown, INR had a panic fall upto RS78/USD. It however recovered the entire lost ground within 5 months, and has been mostly stable around Rs73/USD in 2HFY21.

India’s macro conditions remain challenging despite the complete recovery from recession. Pre pandemic, Indian economy was growing at the long term rate of ~6% (5yr rolling CAGR). Due to collapse of growth in FY21 (-8%), the trajectory has slipped to ~4%. Recovering back to even subpar ~6% trajectory may take upto 5 years (FY26). Considering that India’s demographic needs require consistent 8-9% growth, led by high job creating construction and manufacturing sectors, the growth challenges may not abate anytime soon.

To make the matter worse, the inflation has become sticky and persisting close to upper bound of RBI’s tolerance range. Though RBI has made it abundantly clear that Indian economy cannot tolerate rise in interest rates at this point in time, any further easing of policy rates is virtually ruled out.

Quasi stagflation (for lack of a better term), has therefore emerged as a major policy challenge in FY21.

Conclusion

To sum up, FY21 had been a challenging year. It has dented the core of global as well Indian economy. The markets have come out from it mostly unscathed. It would be interesting to see how FY22 unfolds. I will share my investment strategy for FY22 tomorrow.

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 statistics for economic growth during 2QFY21; consumption, investment, exports and financial indicators etc. for the month of October were announced last week. The data has been received very enthusiastically. The general commentary is that the growth is “surprising”, and the recovery is much quicker and superior that previously estimated. The “buoyant” data and further encouraging news on vaccine development & launch kept the momentum in the stock market busy yesterday.

Since, most of the “surprised” reports are basing their arguments on the “Pre-Covid” and “Consensus Estimate” benchmarks; I find it pertinent to note the data with the usual year on year comparison.

1.    The production in eight core industries has contracted for eight consecutive months. In October 2020, the index of core industries fell by 2.5% compared to October 2020. It is important to note that in the base month October 2019, index had also contracted 5.5%.

While coal, fertiliser, cement and electricity recorded positive growth, crude oil, natural gas, refinery products and steel registered negative growth in the month of October 2020.

During April-October 2020, the index of core industries has now declined 13% as compared to a growth of 0.3% in the same period of the previous year.

2.    After witnessing an uptick in the overall export segment in the month of September, India's exports faltered back into the negative territory, contracting by 5.12% YoY in October.

The worrisome part however is that India has lagged its peers materially in exports growth in past many months. Comparative data of export growth on a three-month moving average basis showed that Vietnam, China and Taiwan have seen the strongest revival, followed by Bangladesh. India and Indonesia have lagged.

3.    India’s GDP contracted for second consecutive quarter on year on year basis. In 2QFY21 India’s GDP contracted 7.5% as compared to the same period in previous year. It is relevant to note that NSO has admitted data availability limitation and recognized a possibility of downward revisions to the GDP data for 2QFY21.

Nominal GDP contracted 4% on account of higher inflation in the quarter. Overall, H1FY21 GDP stands at -15.7%, worse than most of our peers.

I find the standalone growth statistics, independent of “pre-covid” and “consensus estimate” benchmarks, not very encouraging. Though one can certainly draw comfort from the fact that we may not deteriorate materially from the current level of economic activity. But we must recognize that the latest statistics implies two things:

 

2.    The potential growth rate for India’s economy which was bordering 9.5-10% a decade ago, may itself have fallen to 7-8% in these two years. Remember, even this “less contraction: is happening on the back of massively negative interest rates.

 

The increase in value of equity portfolio in recent days is causing more discomfort to me rather than giving any satisfaction. For all practical purposes I am discounting my portfolio by 20%.