Two factors that are likely to revive corporate investments, earnings, credit growth and thereby the equity markets over the next few quarters are a cut in interest rates and increased public spending, especially in the infrastructure space.
While higher government spending may take some time, there is a feeling that with the softening of inflation, a reduction in interest rates is inevitable. The move will not only lift banks and interest-sensitive sectors fundamentally, but is also likely to drive consumption which may provide a much-needed thrust to the manufacturing sector.
As the Reserve Bank of India gears up to review the monetary policy on June 2, all eyes will now be on Governor Raghuram Rajan. With inflation within the RBI’s comfort level and corporate earnings and investment not taking off, the clamour for a rate cut have grown louder over the last few weeks. The call this time around has come not only from industry bodies but also from the chief economic adviser Arvind Subramanian, who recently hinted at the need of a rate cut soon to boost growth.
“The economy has not revived as expected. While interest rate cut is not the only thing required, creation of a conducive environment and lower cost of borrowing is needed urgently to prop up growth. I hope the Governor delivers what is expected of him otherwise both consumption and investment will suffer,” said Abheek Barua, chief economist, HDFC Bank. “It is also important from the point of view that a rate cut will provide an assurance to long-term investors that the environment is turning conducive and therefore it will revive the market sentiments.”
A look at the performance of BSE 500 companies (excluding IT, banking & financial services, pharma and FMCG) reveals that over the past five years, 217 companies (which have announced their results as on March, 2015) have witnessed a sharp decline in their aggregate revenue growth. While the revenue growth had hit a high of 22 per cent in March 2011 (year-on-year), in the year ended March 2015 it contracted 1.6 per cent.
Even the profits have registered a similar trend. While the net profit for the group of companies rose 4.4 per cent YoY in March 2011 to Rs 120,172 crore, the profit has risen by only 4 per cent in the last four years to Rs 124,907 crore in March 2015.
This shows that the state of broader manufacturers in India has weakened over the last few years. Unless their capacity utilisation grows and sentiments revive, they may not be in a position to invest and grow. Experts feel that the government will now have to take the spending initiative for the private sector to follow.
A report titled ‘India equity strategy’ released by Deutsche Bank on Thursday points that while public investment may be the most critical driver for economic revival, until private sector recovers, one of the important triggers for growth revival will be a cut in interest rates. “Triggers that could bring markets out of the current stupor are — a 50 bps rate cut by RBI in the next monetary policy meeting due on June 2 and the passage of the Constitutional Amendment Bill for goods and services tax in the Monsoon session of parliament,” said the Deutsche report.
Who will benefit?
While housing remains a concern area that needs revival, a drop in interest rates by over 100 basis points, over a period of time, may lift the demand for real estate. Overall activity within the sector which, many feel, has the ability to lift several sectors along with it could also improve. So while real estate companies may be clear beneficiaries, banks and financial institutions will also witness a pick-up in their credit growth and even improve the ability of their borrowers to repay and thereby reduce the stress of non-performing assets (NPAs) on banks.
“If you give some interest rate relief to them then the restructured loans won’t slip into NPAs. This will benefit both the borrowers and the lenders,” said Barua.
A rate cut is also expected to come as a booster for capital-intensive sectors that have been deferring investments on account of both high cost and low capacity utilisation. “From a market perspective, a cut in rates will bring in focus the capital-intensive sectors such as capital goods, cement, infrastructure and auto,” said Pankaj Pandey, head of research at ICICIdirect.com.
The Deutsche report, too, points that they expect a domestic recovery and with renewed focus on public investments, they remain overweight on domestic cyclical sectors such as – industrials, financials and materials such as cement. “By far the biggest risk to our base-case emanates from further delay in a meaningful pick-up in public investments, a lesser-than-anticipated monetary accommodation by the RBI, sharp foreign capital outflows on faster and greater than expected FOMC (US Federal Reserve) rate hikes and a sharply deficient monsoon rainfall,” said the report.
The government has been talking of a big infrastructure push especially in road developments, railways and defence-related manufacturing and a decline in rates may act as a catalyst for such investments to have a cascading effect. Moody’s analytics in a note said, “High borrowing costs are hurting the business sector, as manufacturing production grinds lower.”
While domestic equities rallied over the last one year in anticipation of growth in corporate earnings and higher GDP growth, the lull in markets over the last couple of months is a reflection and realisation of weak corporate earnings not keeping pace with the expectations. Even higher GDP growth of over 7 per cent has not reflected in credit growth, private investments and job creation.
Since stock market performance is a function of growth in the economy and future corporate earnings, a cut in interest rates on June 2 may provide the necessary ingredient for growth and a push for the market. With equity markets having witnessed some correction and trading almost 9 per cent below their all-time highs that it hit in March 2015, a cut in rates may provide the necessary impetus and thereby translate into returns for the investors.
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