Indian shares face short-term turbulence from twin factors — Donald Trump’s unexpected victory in US presidential election and New Delhi’s tough actions against unaccounted money — but for longer term investors there will be much to cheer.
Worries about Trump’s big plans to loosen the cash tap to boost growth through tax cuts and investments could quicken inflation and higher US interest rates, which could halt and reverse the flow of capital to emerging markets such as India. Those fears drove benchmark stock indices down more than two per cent on Friday.
Prime Minister Narendra Modi’s abrupt national TV announcement on Tuesday evening to scrap high-denomination currency notes — Rs1,000 and Rs500 — with immediate effect to combat “black money” and counterfeit notes in circulation disrupted normal life in the subcontinent where the vast majority is used to cash transactions for nearly everything.
Unsurprisingly, activity in shopping malls to small traders dropped sharply. There were fewer diners at restaurants and cinema halls reported thinner crowds. Doubtlessly, the shortage of cash will severely curtail consumer spending. It will take weeks for the situation to return to normal and there is the likelihood of an inventory build-up at factory warehouses and production cutbacks in the short term.
For some sectors such as real estate, where the incidence of “black money”, or cash hoarded up without paying taxes, is significant because of high stamp duties, the government clampdown would deal a body blow. Property prices could fall 10-20 per cent while the impact on land prices will be bigger, foreign brokerage CLSA said.
Lenders to property developers could be stuck with sticky loans, Credit Suisse warned. Makers of construction materials could also bear the brunt as slower house sales hit home.
“The move on black money will likely result in demand destruction in the organised real estate as well as individual/rural house construction, which will get transmitted to cement demand in due course,” HDFC Securities said.
Bide your time
Over the longer term, however, the decision to flush out unaccounted cash should provide rich dividends to the economy. If the government succeeds to force a third of the parallel economy to the mainstream, it would be a huge boost to the $2 trillion dollar official economy.
The World Bank estimates the size of India’s shadowy economy at a quarter of GDP. “With a single stroke, 40 per cent of this pie has been obliterated. The remaining 60 per cent is most likely locked up in physical assets such as gold, land and real estate and will suffer secondary damage thanks to value erosion,” Citigroup said in a report.
People have time until next March to exchange or deposit their high-denomination notes in banks. Undeclared cash hoards that are deposited could fetch the government as much as $30 billion in additional tax revenues, according brokerage Macquarie. This could significantly reduce India’s fiscal deficit that stood at around $80 billion in the financial year ended March.
“It is hard to estimate how much of the currency will not be exchanged, i.e., black money that would become worthless,” Neelkanth Mishra, India equity strategist at Credit Suisse, said in a note. “Not all of it is kept in cash under the mattress, but even if this was 20 per cent, it would mean three trillion rupees of wealth destroyed.”
Fewer notes in circulation would mean lower inflationary pressures, and could pave the way for more monetary loosening.
“The good news here is that there could be a considerable drop in interest rates over the course of the next three to six months,” S. Naren, executive director and chief investment officer at ICICI Prudential Asset Management Co, told Bloomberg.
“This would mean that many of the projects which were unviable could become viable as the interest rate subsides. Therefore, over the next three years, we expect a boom in the Indian economy backed by capital expenditure cycle, starting 2018.”
Better off
While export-driven software services and pharmaceuticals could face headwinds if a Trump-led US raises protectionist barriers, most other sectors are unlikely to be impacted because their demand comes from the domestic market. On the other hand, big multinational companies are looking to set up shop or expand their operations in India lured by the potential consumers in the nation of more than 1.3 billion people.
“India is not as dependent on external trade compared to the rest of Asia and of course part of the reason why Asia is under pressure in terms of the currencies and bonds in equity markets is because of the uncertainty around the Trump administration’s policy towards Asia and China in particular. So India is not going to be affected compared to say Singapore or Korea,” Khoon Goh, senior forex strategist at ANZ, told ET Now television channel.
“Foreign ownership of Indian assets is far lower compared to many other countries. Foreign ownership Indian governed bonds for example is pretty low when compared with the 30 or 40 per cent in Malaysia or Indonesia. Because of that, there is a less susceptibility of foreign outflows from India compared to other markets.”
But for Friday’s Asia-wide equities tumble, India’s stock indices would have ended the week with gains. The top-30 Sensex shed 1.7 per cent over the week to 26,818.82 and the 50-share Nifty lost 1.6 per cent to 8,296.30. Although the possibility of more losses are there, the declines should be an opportunity to buy.
Good tidings
Investment bank Goldman Sachs said New Delhi’s drive against “black money” would help the economy in the longer run.
“We see this as positive for the bond market because of the increase in banking system liquidity, eventual positive effects on the tax base and government revenue, and likely short-term disinflationary effects on spending from cash constraints,” analysts at the US bank wrote in a report.
“The rupee may face some volatility near term, but over the medium term, we expect the current account to improve on reduced imports.”
New Delhi’s move is proving a bonanza for cash-strapped banks that have been reeling under mounting bad loans. Long queues at bank branches are a daily occurrence across the country as people rush to exchange and deposit demonetised currency notes. Bank deposits have jumped by nearly Rs. 600 billion.
Government-controlled State Bank of India (SBI), the country’s largest lender by assets, said on Friday it had received Rs. 396.77 billion in savings and current account deposits in two days.
“What I do in a month, I’ve done in a day,” SBI head Arundhati Bhattacharya told reporters. The bank received savings bank deposits of Rs. 110 billion in one day, compared with Rs. 80 billion it normally does in a month.
“Surely the cost of funds is something that is going to ease,” she said, adding that this would lead to lower lending rates.
Little surprise the BSE index for banking stocks jumped 3.8 per cent over the week, while the main indices dropped more than 1.6 per cent. Even after falling 3.1 per cent on Friday following disappointing quarterly results, shares in SBI gained 11 per cent over the week.
Net profit for the three months ended September tumbled an expected 35 per cent from the same period a year earlier to Rs. 25.38 billion as provisions for bad loans almost doubled to Rs. 76.7 billion, SBI said. Gross bad loans as a percentage of total loans rose to 7.14 per cent from 6.94 per cent at the end of June.
With economic growth picking up and borrowing costs coming down, mothballed factories are beginning to brim with activity, which should ease the burden of stress assets. As projects become viable again companies would be in a better position to repay loans.
The writer is a journalist based in India.
