FM talks the market up, but is it a booster dose or a placebo?

At 19X FY20e earnings, markets are not cheap. With earnings likely to remain elusive, the short-lived rally over FM’s announcement is likely to give way to a long-period of consolidation with a hawk eye on cues for decisive revival.

Highlights

The good news – government has acknowledged the slowdown

More measures could be expected

Removal of FPI surcharge, GST refund are welcome moves

Assumption of credit revival and rate transmission too simplistic

Auto sector looking at a long road to recovery – nothing changes with the announcements

Deepening of debt market and infrastructure pipeline deserves immediate attention

Earnings drought continues, valuations not cheap, the wait for a recovery may be long

The Finance Minster finally made her long-awaited announcements on measures to boost the economy. The acknowledgement of the problem at the highest level of the government is reassuring news for the markets, as we can now legitimately expect more follow up actions.

The first round of announcements will definitely provide a short-term boost to sentiment. However, the complete drought in earnings is unlikely to be alleviated by this round of announcements, which by the way has not impacted the fiscal deficit meaningfully. So whether the government’s endeavour turns out to be a booster dose or placebo for the markets is contingent on concrete follow-up proposals that will boost demand.

The removal of surcharge on long-term and short-term capital gains tax for FPI (foreign portfolio investors) is a much-anticipated welcome move but doubts linger on the applicability of the removal on business income of FPIs that has turned out to be a contentious issue post the presentation of the Union Budget.

Some of the other announcements could have an incremental positive impact, such as the infusion of additional liquidity support to housing finance companies by NHB (National Housing Bank) to the tune of Rs 20,000 crore - that could partially alleviate the liquidity challenges. The decision to clear GST dues for MSMEs within 30 days should also ease their working capital burden in these challenging times.

But it’s far from certain the upfront capitalisation of Public Sector Banks will automatically propel credit growth, or a diktat from the government will ensure swifter transmission of interest rate cuts. Slowing credit growth is a fall-out of the slowdown and not its cause.

Transmission of rates has been weak so far and the reasons, such as deposit growth lagging credit growth and higher rates on alternative avenues of savings like small saving schemes, have seen no change. Higher provision on bad loans had also played its part in weakening transmission and that fear has not completely gone away in a weak economy. It may be naïve to assume, therefore, that linking lending rates to an external benchmark will ensure seamless transmission of lower rates. Moreover, the structural issues impacting the current slowdown may not be addressed by monetary transmission alone.

Turning to the automobile sector, the decision to extend the usage of BS IV vehicles, government departments to resume purchase of new vehicles and additional depreciation could marginally improve sentiment but these are not potent enough to take the industry out of its deep slump.

Some of the long-term measures, such as the endeavour to deepen the bond market and creation of inter-ministerial task force to finalise the pipeline of infrastructure projects with a target investment of Rs 100 lakh crore ought to be fast-tracked to make a meaningful impact on the economy. Whether these efforts succeed will of course depend on how well these are formulated and then implemented.

As far as markets are concerned, the hunt for earnings growth would continue and the weekend announcements do little to change the picture. Having said that, it is important to remember that if this is just the beginning of a series of initiatives from the government, sentiments could improve which could pave the way for a better second half, especially since the latter half of FY19 was subdued and the lower base could be a help.

It is important to note that the first quarter earnings picture has been dismal, to say the least, with banking stocks (on the back of lower credit costs) lifting the Nifty earnings to the lower single digits. Excluding those stocks, Nifty earnings growth was negative.

It is also pertinent to note that the earnings growth between FY14 to FY19 was an anaemic 3.5 percent and the projected earnings growth of FY20 in the mid-teens is riding on banking stocks. A perceptible slowdown, resulting in fresh stress on banks, could put a question mark on that growth assumption.

At 19X FY20e earnings, markets are not cheap. With earnings likely to remain elusive, the short-lived rally over FM’s announcement is likely to give way to a long-period of consolidation with a hawk eye on cues for decisive revival.  ​

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