The following charts are useful in
appreciating the previous bull market in India.
Improving interest coverage ratios and
uptick in growth in the first half of the previous decade created a favourable
environment for assuming a long equities posture. The acceleration in equities
post 2005 coincided with a down tick in debt service capacity. This is in tune
with behavioural characteristic of investor attention reacting belatedly to
fundamentals. Cut to the present, coverage ratio is at 12-year lows and yet the
equity index is at levels similar to 2007, when coverage ratios and economic
growth were vastly better.
Improving balance sheet health also
reflected in a down tick in interest expenses relative to revenue until 2006.
Post 2006, this metric has evolved on a deteriorating trend, and bank gross
NPAs have grown at an accelerated pace. Both are at 12-year highs. The broad
economic slowdown is partly to blame; however, blame ought to be apportioned to
bull markets as well, as falling diligence levels incentivise easy access to
capital, even to companies ill equipped to handle debt burdens. The gross NPA
excludes recast loans, which form a good chunk of advances (10% of loans are
NPA + restructured). What could lead to a reversal in this situation? Growth
and a stable inflation environment would offer good starting points. How have
these been panning out?
Two other broad conditions created a supportive environment for
equities post 2003. GDP growth picked up and stayed above long-term trend,
while CPI ducked and stayed below trend until 2008/09. Since then, these lines
have gone in the wrong directions. Achievement of GDP growth forecasts for 2014
& 2015 would still see growth running at 25% below trend, while inflation
would be 30% above trend. Economic slowdown has also reflected in earnings. The
RBI is focused on reining in inflation (the right thing to do), leaving the
reins of economic growth in the hands of the government. As things stand today,
stagflation is the path of least resistance over the medium term.
Given impending elections next year, reforms momentum has been
waning, or being stalled completely. Political will to reform is low and
unlikely to materialise until elections. In relative terms, China outlined a
reform-oriented plan in its Third Plenum. China's pro-reform agenda contrasts sharply
with the stalemated reforms process in India. With the former's economy
expected to grow at a faster pace, capital is likely to prefer China to India
in the medium term.
In
sum, earnings and economic growth have slowed down inexorably, while inflation
is stubbornly high. Things continue to deteriorate on the balance sheet front.
Reversal catalysts are nowhere in sight. In such a scenario, it is hard to
justify the equity market rally on the basis of either fundamentals or possible
electoral outcomes; sentiment and hope - shaky foundations - are the pillars on
which the rally (if sustained) is built.
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