<b>Devangshu Datta:</b> Prospect of bear market looms over India

Between Trump's whimsies and the demonetisation of Rs 500, Rs 1,000 notes, the Indian market and the common man may have to sweat it out

The markets were stirred and shaken through the last week. The US has elected a president, whose hobbies include going serially bankrupt. He campaigned on a protectionist, racist platform. Indian markets were further stunned as 86 per cent of currency was demonetised in a shock announcement. USD bond yields shot sky-high and Indian equity indices crashed.

Markets were anticipating a hike in the American policy rate by the Federal Reserve. Traders are now factoring in higher inflation if Trump follows through on (admittedly incoherently articulated) policies to impose taxes on outsourcing, and to impose high import duties to force jobs to return to the US. The US labour market is tight due to steady employment gains through the Obama years. US wages are high, which is precisely why outsourcing occurs.

 

If Facebook, Apple, Amazon, Google, General Motors, etc are forced to pull jobs back to the US, there will be an inflationary effect, and it will have global consequences, of course. Foreign portfolio investors are pulling out of every emerging market and India is especially vulnerable due to the high exposure of the information technology and pharma sectors to Trump’s whimsies.

The underlying logic of Indian demonetisation also seems incoherent. Given an economy where over 90 per cent of transactions are in cash, 50 per cent of population is unbanked and less than 10 per cent have cards and mobile wallets, it borders on the insane. Cash-dependent sectors have frozen and there is visible pain at the bottom of the income pyramid.

There is little logic is replacing “high denomination” notes by even higher denomination notes in a process, which will take several months in terms of sheer logistics. At the end of the day, the costs of this process may well exceed possible inflows in penal income tax collections and the write-off of Reserve Bank of India liabilities on black currency.  The total currency amounts to about 10 per cent of official gross domestic product (GDP) in value and most of that is actually white. It’s conjectural how much black cash there is, and the velocity is also conjectural. 

The queues at banks and ATMs suggest that this remonetisation process is not being very well-managed. News reports also say the new notes are as insecure as the prior series, which means that counterfeit currency will soon be back in circulation, too. 

By the way, Rs 1,000 equates to about four days earnings for the “average Indian” (official per capita is about Rs 96,000) and that is not “high denomination”, by any definition. Given household savings rates of roughly one-third, the “average Indian” saves Rs 30,000 per year. Add on the informal, legal economy of small traders and service personnel and the savings are higher. A lot of it is cash.

It is not the fault of a plumber, or a day labourer, with earnings well below the taxable threshold, if the Income Tax Department cannot track entirely legal service incomes. Low-level service people like that (along with housewives and domestic helps) will pay the cost of this demonetisation while the rich mostly hold black assets in land, or bullion, or overseas accounts.

Hundreds of millions of under-banked Indians hold large savings in cash, usually in “high-denomination” notes. Bank deposits in the past few days bear out that assumption. Even if the poor have ID (many don’t), bank accounts require local address proofs, which migrant labour doesn’t possess. Nor will banks or post offices open new accounts now, All personnel are working overtime to exchange notes.  

It is likely that post-Diwali rural and semi-urban consumption will crash for a while. Metro consumption is also badly affected. The effects will show, at least partially, in the Q3 profit and loss accounts of listed players in the real estate market, FMCG companies, tractors, two-wheelers, low-end mobile phones, telecom service providers, construction, etc. Fintech companies and cashless service providers will gain in volumes. But unfortunately for investors, those companies are unlisted.

The GDP for Q3 may fall, though there could be some jugglery in the form of transferring reduced RBI liabilities (the RBI will no longer have to honour the promise to pay the bearer of black Rs 500/1,000 notes) to government of India accounts.

Given that Q2 earnings were nothing to write home about, there is some gloom and doom in equity markets. The housing finance sector has crashed. Analysts are doing sensitivity analysis to figure out the potential impact of a decline in transactions, and of probable drop in prices. The USD has also spiked, partly due to higher USD yields and partly because the RBI is completing a reverse swap of $26 billion.

One bright spot: The RBI is almost guaranteed to cut rates again in December. Banks will want to transmit cuts because they will be flush with new deposits. This might not be enough to counter the other signals, which suggest an impending bear market. 

Technically speaking, the market looks likely to travel lower. The Nifty is trading about two per cent above its own 200-Day Moving Average. It has dropped four per cent in the last fortnight. If it drops another 200 points or so, India would be back in a long-term bear market.