2019 was an eventful year for Indian equities, as they posted moderate gains amid a raft of global challenges and domestic opportunities. The National Democratic Alliance (NDA) was elected for a second term in April. After some initial hesitation, it embarked upon an ambitious reform agenda, including privatisation of state-owned enterprises and supply-side reforms such as a reduction in the nation’s corporate tax rate. In this 2020 outlook, Rana Gupta, India Equity Specialist, explains why Indian equities are poised for continuing positive performance this year on the back of long-term structural opportunities provided by the “3R’s” (Recycle, Rebuild, and Reinvestment) and positive cyclical catalysts.
Our 2020 outlook is based on our long-term view of the opportunities in Indian equities that will emerge over the next three-to-five years. In particular, we believe that investors should understand how previous government structural reforms over the past three years, which we refer to as the “4F’s”2, laid a critical foundation for India’s economic growth agenda. As a result, India’s economy has become more formal with better public infrastructure and healthier private-sector banks.
With these fundamental building blocks in place, we believe that the Indian government has a unique opportunity to revitalise investment-led economic growth through the 3R’s: Recycle, Rebuild, and Reinvest3:
In 2019, the government has made notable progress with this agenda, including the selling of SOE assets, slashing the corporate tax rate from 30% to 22%, and offering newly-incorporated manufacturing firms a preferential tax rate of 15%4. Further reforms to improve the business environment were also introduced5. Finally, we are closely watching the government’s progress on labour reform: A bill was recently introduced to simplify many of the country’s rigid labour laws.
In 2020, we believe that the Indian government will propose further reforms based on the 3R’s. These should provide a virtuous growth cycle that not only improves India’s near-term growth prospects but also increases the country’s long-term competitiveness on a structural basis.
In 2019, we saw an active government policy response to decelerating economic growth: active fiscal policy (including tax cuts) coupled with monetary easing by the Reserve Bank of India (RBI)’s multiple rate cuts6 and monetary intervention.
This year, we expect to see positive cyclical factors emerging from fiscal impulse and lower interest rates. Although the corporate tax cuts may lead to a moderate rise in the fiscal deficit, our estimate has risen from 3.3% of GDP to 3.7%. We envisage only mild pressure on both rates and the rupee, as benign global liquidity and decelerating domestic inflation afford room for the RBI to continue with its accommodative policy.
Overall, we expect GDP growth to bottom out during the fourth quarter of CY72019 and gradually recover from the first quarter of CY2020 onwards. We also expect Indian equity earnings growth to pick up in 2020, led by improving growth, lower interest rates, and a reduced tax burden.
Despite this favourable macro backdrop, we believe investors should also pay attention to a number of near-term transient challenges that will continue in 2020.
Government reforms have notably bolstered the formal sector over the past few years; however, income levels in the informal sectors have moderated over the same period. Meanwhile, agricultural income has also stagnated due to lower food prices.
The Indian government has responded by introducing middle-class tax cuts and programmes designed to bolster the income prospects for farmers (PM-KISAN8). These measures, coupled with better rainfall during monsoons and other welfare measures focused on housing and health, have effectively addressed such challenges.
Other significant challenges include credit growth and market liquidity. Credit growth among Non-Banking Financial Companies (NBFCs) has steadily declined due to a freeze in the wholesale money market during most of 2019. Recently, two government-sponsored schemes targeting NBFCs and uncompleted real estate projects (which had loans from NBFCs) have led to lower financial stress and some signs of thawing of the wholesale money market.
We are generally constructive on companies with one or more of the following attributes that can benefit from the 3R’s investment theme:
At the sector level, we are positive on large private sector banks. We expect that they may gain deposit and loan market share, as well as benefit from potential lower credit costs. We also like building materials where lower interest rates should drive real-estate demand. We have already seen a significant improvement in the affordability of real estate and inventory levels have corrected.
From an import substitution angle, we like select consumer durable companies; from an export point of view, we like engineering and chemical companies where India is slowly gaining global market share.
Overall, we believe Indian equities are poised for further gains in 2020. Structurally, the 3R’s provide a robust framework to continue important reforms. Cyclically, potentially faster economic growth, coupled with flexible fiscal policy and accommodative monetary policy, should boost economic prospects. When combined, these positive factors should provide ample opportunities for investors in 2020.
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