Do it yourself

Continuing from my previous post (Bull fatigue or bear charge), I would like to share some of the important things I am presently watching closely to assess whether we are passing through a bull market correction or a proper bear market cycle is underway.

Rural income: The recent corporate commentary has highlighted green shoots seen in the rural demand recovery; while the urban demand continues to remain under pressure. For meeting the latest earnings estimates, continued recovery in the rural demand is, therefore, important. Earnings growth of some sectors like consumers, automobile, textile agri inputs & equipment, etc. materially depend on the continued rural demand recovery.

I note that there are some worrisome signs for the rural economy.

First, the 2024-25 winter has been unusually warm and dry. Several states have witnessed drought-like situations and warm weather. Reportedly, Wheat farmers in the northern regions could be staring at a sharp decline in rabi production. Some farmers are expecting upto 50% fall in wheat production due to warmer winter. Pulses and oilseed crops are also feared to be adversely impacted. (see here).

Second, present El Niño-Southern Oscillation (ENSO) weather forecasts are not indicating a strong preference for La Nina (excess rains) or neutral (normal rains) during the Indian monsoon season (July September). These conditions can change materially over the next three months. Given the importance of a normal monsoon for the Indian economy, especially the rural economy, ENSO developments need to be watched closely.

Liquidity: Banking system liquidity bears a good correlation with stock markets. Post Covid-19 monetary and fiscal stimulus resulted in over Rs12.50 trillion of surplus liquidity in the Indian financial system. This massive liquidity surplus resulted in a sharp surge in asset prices, especially stocks and real estate. That liquidity has completely dried. The Reserve Bank of India (RBI) has systematically withdrawn liquidity over the past couple of years. The system liquidity continues to be in deficit despite the measures (50bps CRR cut and Rs1.5 trillion sustainable liquidity infusion through OMO) taken by the RBI. (see here) A further USD10 billion three-year swap (buy/sell) has also been announced to augment the system liquidity.

However, even after these measures, system liquidity continues to be in deficit, as the RBI liquidity injection has been mostly neutralized by USD15bn sale in open market by RBI to check fall in USDINR; and the rise in the government balance with RBI. Given the persistent selling by FPIs in YTD2025 and worsening CAD, the pressure on USDINR may sustain. Under these circumstances, it is important to see how RBI manages to inject sufficient liquidity in the market. A change in policy stance from “neutral” to “accommodative” may be an important hint.

In the global markets, the US and Japan money supply (M2) has started to rise again in 1Q2025 after falling in 4Q2024; while the money supply in China remains at all-time high.

Inflation: The incumbent US President appears to be quite unpredictable. Regardless, his latest actions, in tandem with his commitment to safeguard USA’s economic and strategic interests at all costs, indicate that the US may impose sharply higher tariffs on imports from key suppliers like China, India, EU etc. These tariffs, if not fully absorbed by the suppliers through a mix of currency devaluation and margin adjustments, could be inflationary for the US. Consequently, we may see higher inflation, higher policy rates and bond yields and a much stronger USD. This could eventually be deflationary for the global economy as a whole.

A stronger USD and JPY, and higher bond yields, could result in further unwinding of carry-trades. Emerging markets economies and assets may face strong headwinds.

India, in particular, could be vulnerable due to slowing growth, expanding CAD, declining FDI, higher relative valuations (continuing FPI outflows), slowly depleting Fx reserve, and contracting yield gap with the US, etc.

A poor monsoon, on the back of below par Rabi crop, could halt the RBI easing cycle, as food inflation picks up and food import bill also rises.

It is therefore important to keep a close watch on the US trade policy, and the inflation trends.

Corporate earnings: the past couple quarters have been disappointing in terms of the corporate earnings, triggering a wave of earning downgrades. After the latest (3QFY25) results, Nifty EPS has witnessed 2-3% downgrade. If this trend continues in 4QFY25, the earning downgrades could accelerate. A leading stock brokerage firm (Kotak Securities) now expects Nifty EPS of Rs 1032 in FY25E, Rs 1179 in FY26E and Rs 1348 in FY27E with the Nifty trading at 22.2x FY25E, 19.5 x FY26E and 17.0 x FY27E.

The Nifty valuations are presently close to their long-term average (10yr). However, as another brokerage (nuvama) highlighted, most sectors are already close to their peak margin. Hence the prospects of a PER re-rating are remote, while PER de-rating are real.

 The former NITI Aayog Vice Chairman, Arvind Panagariya claimed that India may record a real GDP growth rate of 8% in FY23. However, there are not many who would agree with him. The Reserve Bank of India has projected a growth rate of 7% for FY23, in their latest forecast. Most professional forecasters have much lower forecast for the growth in the next few quarters. The average of professional forecasters’ projected growth of the Indian economy for 2023, as per Bloomberg, is close to 6%. In their latest forecast, Goldman Sachs Group projected the Indian economy to grow at 6.9% in calendar year 2022 and 5.9% in 2023. Morgan Stanley Research expects the Indian economy to grow at 6.8% in 2022 and 6.2%in 2023. Fidelity International expects the Indian economy to grow between 5.5 to 7% in 2023.

Recent economic data has been giving mixed signals about the economy. While the domestic sector is showing resilience, the external sector continues to remain a concern.

Weak external sector

The external sector has been weak for a few quarters now. The trade deficit in October 2022 widened to a worrisome US$26.91bn. Exports dropped ~17% in October 2022 on slower global demand; while imports were still higher by ~6%.

Notwithstanding the efforts of the government to improve trade account by import substitution and export promotion; the exports have grown at a slow 4.3% CAGR in the past three years; whereas the imports have registered 14.3% CAGR in the same period, resulting in larger trade deficit. The external situation thus remains tenuous.

…offset by resilient domestic sector

In the domestic sector however there are some signs of stability. GST collections have been strong; credit growth has started to pick-up; manufacturing and services PMIs are indicating expansion and inflation is showing signs of peaking.

As per the Nirmal Bang Institutional Research, “incremental flow of credit to the commercial sector in 1HFY23 is at a multi-year high when compared to the recent past.” A recent report by the brokerage highlights that Incremental credit flow from banks, while being led by retail credit, is now becoming more broad-based, with services (mainly NBFCs), industry (particularly MSMEs) and agriculture also contributing.

As per the rating agency CARE Ratings, the quality of debt being raised and outstanding in India has been improving consistently. The proprietary CareEdge Debt Quality index (CDQI) of CARE ratings is now at almost 7 year high. As per the latest release, CDQI inched up further to 92.74 in October 2022 as compared to a level of 92.70 in September 2022 on account of increase in higher rated debt and upgrades in the investment grade rating categories.

The commentary of most corporate management indicates that rural demand is a matter of concern for now. A good rabi crop could address some of this concern; but overall the growth prospects remain modest. The Indian economy certainly does not face any prospect of recession or even a sharp slowdown; but we may not see any meaningful acceleration also in the next couple of years. The external shocks may create large volatility in the markets and provide good entry points for the money waiting on the sidelines; otherwise we are in a boring market for the next many months.