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The market has taken a leg down post the Union Budget as investors despair about "nothing happening on the ground". Political drama with the DMK withdrawing support to the government and SP raising political rhetoric made investors distrustful about continuation of reforms. As if that wasn't enough, the Reserve Bank of India's (RBI) denial to cut interest rates aggressively, despite, by its own admission, companies losing pricing power and growth plummeting, added to the fire. The divestment programme pursued by the government sucked out liquidity from the market and added to the malaise as investors dumped PSU stocks in the hope of buying these back at cheaper valuations later.
All these events have overshadowed the recent policy initiatives taken by the government, rendering the initial upbeat sentiment short-lived. As a result of this 'risk-off' mode, investors have turned to a more defensive stance with fast-moving consumer goods, pharma and IT outperforming the broader market. The upcoming results season is also likely to be muted, reflecting the effects of the sharp fiscal tightening. The customary spending rush by the government agencies failed to materialise in the March 2013 quarter. The weakness was driven by most real economy sectors, such as autos, cement, metals and capital goods/infra.
So, what could be the way forward?
a) Inexpensive valuations (trading below 15-year average), subdued earnings expectations and ample global liquidity imply limited downside risks to the market.
b) While political discord may continue, compulsions within individual parties would likely avoid mid-term elections. The continued reform process should help bring back investor confidence and it is highly likely that the current uncertainty spurs the government to accelerate the process. On-going diesel price hikes and the recent sugar decontrol should help send a strong signal.
c) Increased visibility of action on the ground and pick-up in new order inflows. Last week, we saw new orders worth 1,200 Mw power plant in Rajasthan, and road projects worth Rs 4,000 crore in MP and the Northeast. It was also encouraging to hear the FM say the frequency of CCI meetings will increase from now on and the upcoming meetings will focus on power and road projects.
d) Better monsoon could help ease food inflation and push RBI to start easing aggressively.
e) The divestment programme needs a rethink. In the process of divesting PSU shares worth Rs 25,000 crore, the market value destruction has been an astonishing Rs 50,000 crore. It was heartening to note that the finance ministry has suggested the option of "share buyback" in case of Coal India Ltd (CIL). Top 10 PSUs are sitting on nearly Rs 2 lakh crore of cash, with Rs 50,000 crore lying with CIL alone. What sense does it make to force CIL to buy coal mines abroad when India has enough coal reserves to last more than 200 years? These cash-rich, debt-free companies should be asked to pay out this as dividend or be utilised tfor share buyback. Also, they should be encouraged to take on some debt for capex to revive loan growth. India needs investment now.
f) Current account deficit needs to be tamed. The government is looking at ways, such as easing FDI norms, to improve foreign inflows. An immediate fix could be to reduce export duty on iron ore. This can immediately bring $8-10 billion into the country and help revive the mining sector.
Buy into this weakness. Key picks are L&T, CIL, NMDC, Axis Bank, SBI, JSPL, Maruti Suzuki, NTPC and Bharti.
The author is head of research, Macquarie Securities
