One year of demonetisation: Short-lived scare for stock markets

Prime Minister Narendra Modi’s decision to ban high-value currency notes triggered a knee-jerk reaction in the stock market, with the benchmark Sensex and Nifty declining seven per cent within a fortnight of the announcement. Several stocks in the microfinance, real estate, and other consumer-facing sectors crashed more than 50 per cent, creating panic and fear in the market. The sell-off was triggered by doomsday projections by economists that the note ban would lead to a prolonged weakness in the economy and further delay the earnings recovery cycle.

The Nifty, which was trading above the 8,500-mark before demonetisation, slumped to a seven-month low of 7,908 on December 26. The BSE Realty and BSE Consumer Durable indices dropped 17 per cent and 14 per cent, respectively, from November 8 to December 26. Blue-chip cement companies UltraTech Cement and Ambuja Cements and paint major Asian Paints saw their stock prices correct 20 per cent each on fears that the cash crunch would dampen demand. Non-banking finance company stocks such as Manappuram Finance, Bharat Financial Inclusion, and real estate stocks such as Delta Corp plummeted over 40 per cent from their pre-demonetisation levels till December 26.

Fortunately for the Street, the pain lasted less than two months as the markets bottomed out on December 26 because of buying support from domestic institutional investors, mainly mutual funds (MFs).

MFs got a shot in the arm from demonetisation as surging bank deposits got channelled into their equity schemes. Taking advantage of the weakness, MFs stepped up buying, purchasing shares worth Rs 24,000 crore in November and December, even as overseas investors dumped shares worth over Rs 26,000 crore during the same period. The note ban announcement clashed with the global uncertainty created by Donald Trump’s surprise victory in the US presidential elections.

While the jury was still out on the economic and earnings impact due to demonetisation, the stock markets shrugged all worries and charted a sharp recovery. Foreign institutional investors (FIIs) joined the party from January-end amid a revival in global risk appetite. In February and March, FIIs invested Rs 10,485 crore and Rs 33,782 crore, respectively, lifting the Nifty 15 per cent from its note ban lows.

Globally, investors — who were initially apprehensive of Trump’s protectionist stance — started lapping up risky assets on optimism that Trump would announce a cut in corporate tax and boost infra spending.

Also, stability on the geopolitical front and the benign stance by global central banks provided ample liquidity for FIIs to invest in equity markets around the world, including India.

The 30-share Sensex, which had declined to 25,807 on December 26, closed above 30,000 on April 26 for the first time, and went on to climb to 32,000 by end-July and breached the 33,000-mark in the last week of October. A unique feature of this rally has been low volatility. The India VIX index, a gauge for market volatility, has averaged only 13 since the demonetisation lows of December 26.

Declining bank deposit rates and dimming assets of other asset classes such as real estate, accelerated flows into MFs. Since November 2016, equity MFs saw a massive Rs 1.25 lakh crore of flows. The huge FII buying seen during January-February subsided over the next few months and since August they turned into huge net-sellers. Since August, FIIs have pulled out Rs 26,000 crore from the cash market. However, this failed to make a dent because of aggressive buying by domestic MFs.

Despite the rally, the fundamental concerns about the economy and corporate earnings continue to puzzle analysts. The 20 per cent gain made by benchmark indices since November 8 has been largely on the back of valuation expansion. The markets currently trade at over 20 times its one-year forward earnings, compared to the long-term average of 16 times.

Demonetisation, coupled with the introduction of the goods and services tax, has deferred earnings recovery by at least three quarters. Analysts are hoping a sharp revival in corporate earnings from the December quarter onwards, albeit on the low base created by the note ban.