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The Nifty went up seven per cent in 2013. It was disappointing after a 28 per cent rise in 2012, but a respectable performance, given the concern on economic slowdown, currency volatility, inflation and the policy paralysis. The disappointment was the absence of structural reforms. Instead, we had only temporary measures to control the fiscal deficit and current account deficit (CAD), such as stop-and-go in programme expenditures and effective stoppage of gold import, which buy time but do not address the structural issue of economic growth.
Introduction of another social programme aimed at the rural poor, the lack of progress in subsidy reform in fuel and in Goods and Services Tax were clear disappointments. The price of diesel has risen but the actual under-recovery remains the same as last year. The recent gas price rise might increase the overall subsidy burden. The World Bank's 'Doing Business Survey, ranks India 134th among 189 nations, highlighting the difficulties businesses face.
On the other hand, the new Reserve Bank of India governor brought needed credibility and the currency has stabilised. Gradual depreciation of the rupee might be inevitable, given the inflation differential. But, the volatility can be contained by predictable policies. Despite tapering, the US long-bond yield remains stable. From this perspective, the tapering process was thus far well managed by the Fed.
While some liquidity outflow from emerging markets is happening, the market will eventually distinguish India, which has good growth potential, with CAD manageable. High inflation is still an issue but the recent pre-emptive rise in the policy rate is helping the rupee to stabilise. The best scenario for the market this year is that a party with pro-growth, pro-development policies wins with a clear majority at the parliamentary elections, the inflation comes down as food prices come down, paving the way for RBI to reduce rates. As the equity market is forward looking, the market can look through the weak economy and have a great year. Can we have one?
The obvious known-unknown is the election result. The market has already factored in a Bharatiya Janata Party win but the degree of winning is the big question and the volatility around the elections can be significant. More fundamentally, the chance of revival in capital investment this year remains slim. Consumption is under pressure due to inflation and a weak job market. The sense of stagnation could intensify further. Even with a favourable election result, the reality on the ground cannot be changed overnight. Removing uncertainty over coal allocation, increase in coal output, resolution of mining bans in various places and re-starting various stranded projects take time and resolution. On the monetary front, inflation remains far from satisfactory. RBI repeatedly stated that inflation and inflation expectations remain its priority and in that context, it is unlikely for RBI to reduce rates till the inflation figure improves.
Outside of India, though tapering in the US might be manageable, another tapering from the ballooned credit in China in the form of so-called shadow banking needs to be carefully managed by the Chinese government. The market has not yet seen a credible exit policy on this front, which might cause volatility for EM assets, especially in countries with high inflation and CAD concerns.
Despite macro challenges, there are a number of investment opportunities. Infrastructure would be an obvious area for post-election policy drive. Internet penetration is still low but growing rapidly, opening an opportunity for mobile data and e-commerce. Agricultural productivity must rise to feed the increasing population with different tastes (more protein). Enablers of farm productivity increase are likely to prosper. Investing in export-oriented information technology and pharmaceutical sectors provide a good hedge against the potential of tapering risk re-surfacing. In industrials, as and when the demand improves, corporate earnings and more important, cash flow would expand because capital expenditure has already peaked.
Despite the recent rally, the discount in mid-cap valuation relative to large-cap remains large. In summary, as the market valuation remains at attractive levels, close to the historic average, one can expect the market to yield a return similar to that of profit growth. Favourable inflation conditions and the election result can only increase the prospect for better returns.
The author is CIO equity, LIC Nomura Mutual Fund
