MODI 2.0 Where Should Investors Focus Now?

It looks like Modi’s second term will be more challenging than his first term owing to the daunting economic issues. Will Modinomics pull India out of the quagmire and will investors be rewarded in the next 5 years? Yogesh Supekar takes a stock of the current economic situation and identifies investing opportunities, while Shohini Nath summarises the NDA's focus area for the next term.

While the nation is still digesting the victory of their favourite leader, the Modi 2.0 government has already hit the ground running, putting efforts to put the economy on a higher growth trajectory. 



"A politician should have three hats. One for throwing into the ring, one for talking through, and one for pulling rabbits out of, if elected."
- Carl Sandburg

The latest economic data has not been encouraging. The GDP growth has slipped below 6 per cent in the latest quarter, Q4FY19. The slowdown was expected given that it was an election year and the whole government machinery may not have been able to focus on the economy. Having said that, the task in hand for the new Modi government, that is Modi 2.0, seems to be daunting.

Indian economy is faced with a slowdown and the risk is that we have not arrested the slowdown yet. Will the economy growth take a U-turn and head northwards from here? After the downslide is arrested, the focus will be on the steps that the Modi government takes to propel growth in the economy.

Current economic challenges
The Indian economy has slowed down due to rising global volatility, normalised monetary policy in advanced economies, trade war and investment re-routing to developed economies. The crude oil price rise has also been a factor that affected the Indian rupee negatively. Having said that the rupee has outperformed other Asian currencies and is the top performer amongst the Asian currencies in past three months. The unemployment is high and will influence the priorities of the next government. During January–April 2019, almost 42 million people were willing to work, but did not find jobs according to the Centre for Monitoring Indian Economy (CMIE). Such high unemployment rate suggests a bumpy ride ahead and needs immediate attention of the government.

There is a liquidity issue in the market with several NBFC struggling to get access to funds even as, on the ground, it looks like NBFCs with good track record are able to raise money without much difficulty.

The various projects undertaken by the government will require large amount of capital, which may lead to huge government borrowings. There is a risk that such huge borrowing will crowd out private investment in India. Such crowding out may nullify benefits out of the rate cuts expected in the coming quarters.

Crowding out of Investment

Crowding out is an economic phenomenon where the government spending or the public sector spending drives down the private sector spending. It simply means that the government has increased its borrowings, which results in substantial rise in the real interest rates, which has the effect of absorbing the economy’s lending capacity and, in turn, discourages businesses from making capital investments.

Some of the major hurdles impacting the economy are emerging from domestic issues. Manufacturing has not picked up and we are also faced with an agrarian crisis. The agriculture sector grew by 2.8 per cent in three years, which was also the slowest growth rate in many years. The PSUs continue to bleed and utilise the government resources inefficiently. The exports have not grown even during the period when the global economy recovered. Now that the global economy is showing signs of weakening, there is a possibility that exports may slow down further. With such challenges facing the economy, following could be the priority of the government:-

✓ Quick recapitalisation of PSU banks
✓ Rate cut to support financial sector and overall growth
✓ Keep fiscal deficit at manageable levels
✓ Solve the skill shortage issue
✓ Address unemployment issue



Modi 2.0: The brighter side

There is a consensus that there will be major land and labour reforms which will support manufacturing growth in India. The latest manufacturing PMI data has suggested a good recovery and has hit its 3-month high. This hints to some recovery in the economic growth going ahead. Subhash Chandra Garg, the Finance Secretary tweeted, “Turnaround in demand and financing conditions is beginning well. PMI Manufacturing is at 52.7. Government bond yield has gone below 7 per cent. Rupee is below 70. These are sure signs of coming high growth”.

"We expect Monetary Policy Committee to cut repo rate by 50-75 bps and CRR by 25-50 bps in FY20E"
- Elara Capital

Normally, when any economy is facing a slowdown, it is common to see governments adopting expansionary fiscal policies and liquidity easing. Expect expansionary measures to be taken in the budget this season, which should push the aggregate demand in the economy higher. The fiscal policy suddenly has become very important and investors will be keenly watching the contours of the fiscal policy statements. While the whole world will be watching the decisions taken by the Modi 2.0 government on the fiscal front, experts are cagey on the fiscal deficit front. Come what may, the fiscal deficit should not widen from the current levels.

If we consider the aggregate demand (GDP) in the economy to be a function of consumption, investment, government spending and exports minus imports, one can expect steps to be taken by the government to address each of these levers that influence the GDP.

During high GDP growth period, you will see that the consumption in the economy along with investments and government spending will be on the rise. The exports will be higher than the imports, which supports the economic growth during such periods.

Aggregate Demand in Economy (GDP) = Consumption + Investment + Government Spending + (Exports – Imports)



Currently, the consumption in India is slowing down in the economy and there is lack of private investment. The government spending is happening, but at a much slower rate than what is optimal to push growth. The exports are struggling against the imports. Reducing interest rate is just a starter which will help address the consumption, investment and government spending issues, but it is not the only tool to address the slowdown issue.

According to Confederation of Indian Industry (CII), India will need $1 trillion investment a year to see GDP growing at 10 per cent. CII also has a wish-list wherein it wants the government to focus on industrial growth by starting with select high impact sectors such as capital goods, textiles and electronics. These are also the sectors which can generate good amount of employment.

While there is no doubt that the cost of equity has to come down to bring back the animal spirits, the Catch-22 situation for the government is that for investments, especially private investments, to happen, the growth needs to be in place and for growth to happen, we need more investments. Modi 2.0 we believe will resolve this conundrum in the coming quarters and we can expect investments to pick up.

Global investment banks are bullish on India and they do sense an opportunity for investors to participate in one of the fastest growing economies in the world. With Modi 2.0, global investors are aware there is no political risk involved while taking exposure in India. That cannot be said about other emerging countries. Hence, despite rich valuations and the discomfort with the liquidity situation in India, foreign institutional investors (FIIs) are still betting on India. The increase in fund flows from foreign countries do point to increased optimism post the election results. The domestic fund flows have slowed down a little bit, but are positive, nonetheless. Modi government brings an element of certainty in the markets, which is valued by global investors the most. Expect good participation from global investors in the coming quarters as well.

"FPI equity flows into India in May to date have been USD 1.28 bn vs -USD 1.2 bn for Brazil, -USD 3.7 bn for Taiwan and -USD 977 mn for South Africa."

India economy has the potential to grow in double digit despite several headwinds. With a strong mandate, the current Modi government is in a best position to take tough decisions and put the economy back on track. While doing so, the risk of higher than desired fiscal deficit will remain. The biggest risk to Indian economy remains a poor fiscal policy, higher crude oil prices and worsening domestic demand. All eyes will be on the budget and chances are it will be an expansionary one, which will also set the tone for growth-oriented five years.

Where should investors focus now
There is an increasing chorus around slowing economy growth in India and as the priority of Modi 2.0 shifts from everything else to GDP growth, as mention earlier expect steps to be taken to boost the aggregate demand in the economy. When that happens, one can expect almost all the sectors to recover and do well. Broader markets should do well in Modi 2.0 era in our view and the rally in stock prices will be much more broadbased.

Having said that, the focus of Modi 2.0 in order of priority is likely to be
✓ Education
✓ Agriculture
✓ Infrastructure
✓ Defence

Following new promises have been made by the BJP in its manifesto:

Education & Employment

 Enable investment of Rs. 1,000 bn in higher education via Revitalising of Infrastructure and Systems in Education (RISE)
 Work towards increasing the number of seats in premier educational institutes
 Establish at least one Atal Tinkering Lab in every block
 Launch a new 'Entrepreneurial Northeast' scheme, which aims to provide financial support to MSME and for employment generation in the Northeast states

Agriculture

 Provide adequate market avenues for realisation of MSP through e-National Agriculture Market, Gram Swaraj (GrAM) and PM Pradhan Mantri Annadata Aay Sanrakshan Abhiyaan (AASHA) Yojana
 Cover all farmers as income support under PM KISAN
 Plans to launch a pension scheme for small & marginal farmers to ensure social security after age of 60
 Provide short-term new agriculture loans up to Rs. 100,000 at 0% interest rate for 1-5 years on the condition of prompt repayment of principal amount.
 Work towards digitising land records.
 Assist fishermen under Matsya Sampada Yojana
 Will launch a National Bee-keeping and Honey Mission to double honey production from the current 115,000 tonnes
 Launch a National Feed and Fodder Mission to eliminate shortage of fodder
 Enable creation of 10,000 new farmer producer organisations

Infrastructure

 Strive to achieve 10% blending of ethanol in petrol
 Ensure the supply of piped cooking gas in major Tier-1 and Tier-2 cities
 Ensure conversion of all viable rail tracks to broad gauge by 2022
 Make efforts to ensure electrification of all railway tracks by 2022
 Start developing smart railway stations across India.
 Achieve the goal of Clean Ganga by 2022
 Will launch a National Urban Mobility Mission

Defence

 Focusing on Zero Tolerance towards terrorism and extremism
 To focus on Make in India in Defence in an effort to enable indigenous production of defence equiment.
 National security and modernisation of the armed forces
 Strengthen border security

Source : BJP Manifesto

Investors can focus on interest rate sensitive stocks as rate cuts may happen more frequently under Modi 2.0. The auto sector and financials could be the biggest beneficiaries of such rate cuts. Within the infrastructure space, cement stocks will remain in the limelight along with select real estate and construction stocks.

Conclusion

Stable government, low inflation, possible continued rate cuts in the US and in India, improvement in GDP growth, recovery in manufacturing as indicated by manufacturing PMI data and an expectation of a normal monsoon, all point to a fairly good season for equity markets, going ahead. We are confident that Modi 2.0 will ensure that the consumption story is not only back on track for India, but also will prove to be a growth engine for the economy. Modi 2.0 may ensure there is more money in the hands of consumers. Consumer-facing businesses may see some recovery in growth and will start looking attractive.

Aggressive rate cuts could help settle the liquidity crisis and bring the cost of capital down for corporate India, leading to improved profit margins and repaired balance sheets. The fiscal policy will be an expansionary one and may benefit the agriculture, education, infrastructure and defence sectors. The investments will pick up in the coming quarters as the growth strategy is revealed to the stakeholders. India equities will fetch a premium for itself under Modi 2.0, so don't be surprised if the PE levels inch up further.