When the Indian government announced the demonetisation programme in November, it made headlines around the world and led to some short-term volatility in the Indian equity market. In the aftermath, India lost its title as the world’s fastest-growing major economy,1 but we think the demonetisation programme has not been as disruptive as many observers had first feared and expect the impact of the currency replacement programme to be short-lived as new notes come into circulation.
With key state elections coming up this year, markets had anticipated a more populist budget than before. Instead, the focus of this year’s budget actually fell on fiscal consolidation—namely reducing the deficits of the government. We think this more fiscally conservative emphasis could help economic growth recover in the next two quarters.
In our view, the latest demonetisation move should be viewed against the backdrop of other far-reaching government policies. Despite the short-term impact from demonetisation, we think long-term measures such as the Goods and Services Tax (GST), financial inclusion schemes and improved efficiency in government schemes could make India’s long-term path much clearer.
The long-term focus on growth was clear in the budget. The transform, energise and clean agenda remained close to Modi’s core themes of maintaining fiscal discipline, with an emphasis on long-term fiscal health, higher spending on infrastructure, greater tax compliance and welfare funding.
Room For Growth With Indian Equities
The Indian equity market reacted positively to the budget, rallying on the back of relief from the lack changes made to long-term capital gain tax on equities. We still see room for further gains. India’s equity market is one of the most diverse markets in the world and has demonstrated resilience to external shocks. There are still a low number of domestic investors holding Indian equities, but this appears set to change.
The Indian government has also made efforts to attract foreign investors. These include scrapping the need for prior approval from the Foreign Investment Promotion Board (FIPB) and simplifying the foreign direct investment (FDI) process. As FDI flows become more long-term oriented, we have seen FDI inflows increase by 18% during the calendar year of 2016.2
That said, we think volatility from domestic corporate earnings could increase too, as some companies—namely in the consumer discretionary sector—will likely tide over the impact of the demonetisation programme, due to the lack of cash flow.
Sectors to Watch
This year’s balanced budget maintained a commitment to fiscal discipline, although some may have felt the Modi administration played it on the safe side.
- The government’s focus on rural India and further tax rate cuts for lower-income taxpayers should likely benefit the companies able to deliver cheaper goods and services within this space.
- The ban on large cash transactions could benefit organised players—registered companies that comply with government regulations and tax liabilities—in the jewellery industry.
- The impact of the demonetisation programme has not completely disappeared and it would not be surprising to us if domestic corporate earnings remained volatile in the short-term. As a result, the consumer discretionary sector is likely to feel the effects.
- Fiscal consolidation outlined in the budget should continue to improve the current liquidity outlook and offer some room to cut deposit rates, which have seen some recent pressure from lending rate cuts.
- We think the budget will likely have no direct impact on Indian banks, but we feel the indirect benefits could potentially be plentiful, namely through digitisation, softer rates and economic growth.
- A profit-linked scheme for affordable housing should boost demand for cement and other key house-building materials.
- Some 60% of the budget for infrastructure has been allocated to transport—railways, highways, the metro, irrigation and ports.
In our view, the 2017-18 Union Budget struck a balance in regard to projected government spending—tackling the deficit, while supporting sector growth through public spending. The former maintains India’s credibility and investor confidence, while the latter gives economic growth the lift it very much needs after the demonetisation programme. As a result, we see numerous potential opportunities for investment in domestic sectors that should drive the domestic Indian equity market and pave a sturdy path for fiscal consolidation.
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1. International Monetary Fund, World Economic Outlook, January 2017.
2. Department of Industrial Policy and Promotion, December 2016.