Shashank Savla

India’s stockmarket performance at odds with economic slowdown

Shashank Savla

India’s real GDP growth slowed to only 4.5% year-on-year in the third quarter of 2019, the slowest rate since the first quarter of 2013. This sharp reduction from the 8% levels seen at the beginning of 2018 was driven by a combination of a slowdown in consumption, investments and exports.

Shashank Savla: India’s stockmarket performance at odds with economic slowdown

In our view, one of the key reasons for the growth weakness is the fallout from the credit crunch in the shadow banking sector brought about by the default by Infrastructure Leasing & Financial Services (IL&FS) in mid-2018. This reduced the ability of many shadow banks to roll over their short-term debt or raise new financing and consequently hampered their capacity to disburse loans. The real estate and automobile sectors seem to have been most impacted by this liquidity squeeze. A slowing global economy and persistent non-performing loans at India’s state-owned banks only added to the difficulties.

The Indian government has announced several measures to arrest the momentum. Corporate tax rates were recently cut from 34% to 25%. In addition, a reduced tax of 17% on new manufacturing facilities is aimed at incentivising domestic companies to bring forward capital expenditure plans as well as attracting firms planning to shift manufacturing facilities out of China amidst the ongoing US-China trade war. To tackle the real estate slowdown, a Rs250bn fund to revive stalled housing projects has been planned.

The government is also said to be discussing a proposal to create a special purpose vehicle backed by the Reserve Bank of India to buy stressed assets from financial companies, like the TARP programme in the US. There is also a plan for an industrial relations bill which will allow companies to hire workers on fixed term contracts of any duration. Both these measures are potentially significant, however there are few details yet and it remains unclear if the government will be able to follow through with its implementation.

The growth slowdown has led to lower tax revenues and the planned stimulus measures will put additional pressures on the India’s fiscal balance. The government is now stepping up efforts of strategic divestment or privatisation by selling majority stakes in a few state-owned companies. However, as seen in 2001-02, privatisation can be a time-consuming process and to achieve much in the current fiscal year ending March 2020 seems a stretch. The government is likely to miss its target of limiting the fiscal deficit to 3.3% of GDP.

In contrast to the economic growth slowdown, India’s stockmarkets have been quite strong, with the Nifty reaching its all-time last week before the GDP report was published. Valuations have become even more stretched, and at a forward price/earnings ratio of 18.5x India now trades at a significant 35% premium to the broader Asian region. We see the current steep valuations as unjustified and remain cautious on the Indian equity market outlook in the near term.

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Thursday, December 5, 2019, 4:04 PM