Investors have been calling for a turn in the economy for more than 18 months now, more or less within six months of the National Democratic Alliance (NDA) coming to power. Those hopes have been belied - partly due to lack of adequate concrete reform measures on the part of the government and partly due to the extent of the economic mess inherited. Many investors have grown tired waiting for an economic acceleration and are sick of seeing a continuous decline in earnings expectations. Most do not believe the official seven to 7.5 per cent growth numbers, with five to 5.5 per cent being the perceived true picture in most investors' minds. The fact that most companies and management teams continue to moan and groan about economic conditions, and seem totally disinterested in new projects has not helped investor confidence. Neither have record low profit margins and cash flows. Whatever economic positivity was left has been destroyed by the doom and gloom coming out of the banks, most of which seem totally paralysed and show continued balance sheet deterioration.
However, as is typical, just when most have given up and even stopped thinking about an economic revival, the signs of a turn are becoming more visible.
Just look at the data; electricity production grew by 9.2 per cent in February 2016, versus 0.7 per cent in November 2015. Cement production grew by 13.5 per cent versus -2.6 per cent year on year in November, and port volumes were up 13.4 per cent as compared to one per cent in November. Two-wheeler sales, a very good barometer of rural and semi urban demand, have shown good acceleration in the last three months, now growing by 13 per cent y-o-y in February compared to 1.5 per cent growth in November. The Naukri job index in February is up 18.2 per cent as compared to less than 10 per cent in November. Within commercial vehicles, we have seen growth broaden from just heavy commercial vehicles/haulage trucks to tippers and light and medium trucks. This broadening of demand implies genuine activity on the ground, not just market share shifts from rail to road. Tippers are used only for mining and construction activity and LCV's for last mile transport (no threat of rail substitution). Freight rates have also continuously improved over the past three months, more than justified by the rise in diesel prices. There obviously seems to be enough freight to move. Construction equipment sales have also improved, with feedback from JCB indicating sales surging by 40 per cent in the last four months, along with a pick-up in after-market (implying strong usage).
Oil consumption growth is up from 6.6 per cent in November to 11.7 per cent in February, and many retail formats like Big Bazar, Shoppers Stop, Westside are reporting high single digit same store sales growth. Coke sales have also accelerated by 15-20 per cent. Road traffic growth for both IRB and Ashoka Buildcon has accelerated to near double-digit growth compared to three to four per cent 18 months back. After a gap of almost 12 months imports ex-oil and gems has again moved into positive territory. Both FDI and foreign tourist arrivals are surging.
Obviously all data points are not positive: passenger vehicle sales have slowed to single digits from 11.5 per cent in November and the feedback and sentiment on the ground for cars is not strong. This could be due to the recent hike in cess as well as the issues around diesel cars. Rail freight volumes are still marginally negative, but this is due more to loss of market share than a decline in freight volumes in the economy. Exports remain negative, but this seems to be more about the weakness in the global economy. The private sector continues to show no appetite to put up new projects, and hence no surge in capital spend seems imminent. The data here remain very mediocre. The banks have been shaken and credit growth has dropped to only 11.5 per cent.
Jefferies, the broking house, maintains an activity index, taking many of the above indicators into account. The three-month moving average of this index has seen growth rising to 4.7 per cent, a 12-month high. It also has a momentum indicator, which is also signalling improvement, with only six out of 36 indicators worsening. Thus just when most people have given up, signs of a revival are growing. These signs are before we have seen any impact of the pay commission award and One Rank One Pension pay-outs. This stimulus should only add further impetus to the nascent recovery. We of course need a reasonable monsoon, given the poor rains of the past two years and the need for relief in rural stress.
The banking system is another big vulnerability. If the banks freeze, caught in the headlights of judicial and investigative review, they can short-circuit any revival. For the revival to gain steam, we need to see credit growth accelerate. We need to ensure that the needed banking clean-up does not exacerbate the balance sheet recession in corporate India.
The NDA government has seemingly found its feet and seems to have regained political and legislative momentum. We have Parliament finally functioning again. With good prospects of critical Bills like the bankruptcy code getting passed in addition to the real estate and Aadhaar Bills already becoming law, the feeling of legislative stalemate has ended.
If the economy gains momentum, that is a big positive for markets, given the strong macro of low inflation, falling rates, and a stable rupee.
There is also a strong chance that corporate earnings will finally deliver somewhere near consensus growth expectations of 15 per cent in FY17, given the low base and steep cuts already made in earnings expectations. If in fact growth gains traction, I would expect earnings to outpace current expectations.
While it has taken much longer than most thought, and the private sector capex cycle remains absent, we finally seem to be on the verge of acquiring economic momentum. Now we have to make sure we do not get side-tracked by non-economic distractions or anti- market economic policies. While all data will not be uniformly positive, it never is at turning points. We may also see some of the above data oscillate between positive and negative, but this is par for the course at this stage of the cycle. The markets and economy are not going to go one way up. We are probably still two quarters away from clear evidence that things have turned. But when the evidence is clear, markets will not give you a chance.
The markets may be sensing a turn in the economy - the market action and sector rotation imply better days ahead.
The writer is at Amansa Capital. These views are his own
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
