Thank God It’s Friday: 1st Round Of Stimulus By FM

Indian FM announced a slew of measures to help revive the economy and improve business/investor sentiments with a promise of more measures in the coming days. Key decisions included the reversal of surcharge on long and short term equity capital gains for domestic & FPIs, upfront PSU bank recapitalization, demand support measures for the auto sector, measures to boost liquidity for NBFCs/businesses and measures to contain ‘tax harassment’ concerns.

The broader announcements may not kickstart the economic revival from word go, given the very high level of pessimism. However, these announcements and expectations of more over the next couple of weeks are likely to improve investor sentiment and should drive at least a short-term bounce, as the government has given a clear signal that it acknowledges the economic slowdown and is willing to act promptly to address the issues.

Taxation Measures: Positive for FPIs flows

The government has finally acceded to the key demands for reversing higher taxation on a section of FPIs. During July & August (till date) alone, FPIs have pulled out almost Rs.23,000 crore from the domestic equity market, as the budget proposal levied a surcharge on higher tax income groups affecting ~40% of FPIs operating as trusts or AoPs in India.

Withdrawal of Angel Tax provisions for Startups and their investors to mitigate their genuine difficulties has also been announced. The FM has promised a more comprehensive review of the recently imposed HNI surcharge on incomes in FY22.

Auto Sector: Demand boosting measures

The announcement of an additional 15% depreciation (now it is 30%) on all vehicles acquired till 31st Match 2020 is likely to aid clearing the inventory for Passenger Vehicles (PVs) & Light Commercial Vehicles (LCVs). The government has also lifted a ban on the purchase of new vehicles for replacing all old vehicles by its departments. Although its contribution could be insignificant from the overall PVs market perspective, it does have a positive impact on overall sentiments.

Other measures like deferring the revision in one-time registration fees till June 2020, maintaining the full registration period on BS-IV vehicles bought before 31st March 2020, would definitely support the ailing sector. Moreover, the government will soon come up with a scrapping policy for the vehicles.

PV sales contracted for the 8th consecutive month

Source: CMIE, Kotak AMC

Two-wheelers sales have been falling in recent months

Source: CMIE, Kotak AMC

Banks recapitalization: A shade +ve

The upfront capital infusion of Rs.70,000 crore in PSU banks is likely to boost bank system liquidity (Govt expects it to support Rs.5 trillion of additional credit) as well as help PSU banks in meeting expected rise in their credit costs over next 2-3 quarters.

Further, PSU banks would be launching repo rate/other external benchmark linked loan products for Home loans / Auto loans / Other retail loans as well as working capital loans. As we speak, the interest rate differential between the prime rate on home loans for repo linked and MCLR-linked loans is 30-40bps. But we have to wait for the detailed guidelines by RBI on linking loans to external benchmark for all banks before you could see lower EMI on your Home loans / Auto loans / Other retail loans.

While the jury is still not out on the acceptance of this product, we expect a limited impact on mortgage (housing) growth as it is a function of multiple parameters related to the real estate sector like developer leverage, completion timelines, etc.

NBFCs: Throws lifeline to this ailing sector

Increase in outlay for NHB’s refinancing scheme and moral suasion provided to PSU banks to fast-track collaboration with NBFCs for co-origination of loans to MSMEs, small traders’ self-help groups and MFI client borrowers which would provide additional liquidity to them at reasonable rates. However, we need to take a few more steps to address the heightened level of risk aversion in the banking sector concerning real estate developer & large LAP exposures of NBFCs/HFCs.

Otherwise, these measures will only result in PSU banks increasing their exposure to a couple of well-managed, strong promoter backed NBFCs /HFCs like HDFC, LICHF, etc. They might not increase their exposure to NBFCs / HFCs with a significant developer and large ticket size LAP portfolios.

The economic slowdown is very evident!!

Indian economy is witnessing slowdown which is evident from the high-frequency indicators. The reasons for this slowdown can be explained by tight liquidity, high real interest rate, credit restrictions on the NPA afflicted PSU banks, a slowdown in overall loan growth amidst liquidity stress at NBFCs, ballooning Indio’s trade deficit with China, several key infrastructure projects moving very slowly along with unpredictable policies to a certain extent.

Slowdown In New Investment Projects during last several Qrs

Source: CMIE, Kotak AMC

Volume of stalled projects has started edging up

Source: CMIE, Kotak AMC

Sectoral Capital Investment Trends for Key Sectors (Rs. Lakh Crore)

Source: CRISIL Research

Market Valuation looks reasonable…

We believe these announcements may not kickstart the economic revival immediately, given the extreme level of pessimism. However, this along with the expectation of a few more such announcements over the next couple of weeks will surely improve investor sentiment and should drive at least a short-term bounce-back.

The long-term upward trajectory of the market will be driven by actual corporate earnings growth driven by improvement in the economic outlook, improvement in global macroeconomic conditions and de-escalation in the US-China trade war.

Currently, the market is trading close to their long term average and the yield gap also indicates that we are not far away from fundamental buying levels, unless there are big earnings cuts from here.

Sensex in ‘Fair Value Plus’ Range

Source: Bloomberg, Kotak AMC

India’s Market Cap to GDP (%)

Source: Bloomberg, Kotak AMC

How should we position ourselves?

Unless you have the right asset allocation, your portfolio must be bleeding in recent months. Out of 50 stocks in NIFTY, only 15 witnessed 26% YoY return (July 19) while 35 stocks witnessed a negative 20% return.

Only a few stocks are driving the NIFTY 50 return

Source: Bloomberg, Kotak AMC

Extreme Divergence In Large, Mid & Small cap companies

Source: Bloomberg, Kotak AMC

We recommend increasing exposure to Mid-cap & Small-cap funds as Nifty mid-cap & small-caps relative valuations vs Nifty 50 has corrected back to 2014 lows. We expect improving liquidity & reducing interest rates could help mid-caps & small-caps as it has done in the past.