Swift off the block with loss of steam at the last mile
The NaMo success story (and resultant valuation impact) since mid May 2014 to 1st week of March 2015 is from mix of luck factors from external cues, hope factors from domestic economic revival given the political stability, and euphoria factor from NaMo personality traits around execution capabilities. The external cues were largely driven by fall in Brent Crude price from over $115 into 45-60 (by over 50%) and huge FII flows against QE and Zero (or negative) interest rate regime in developed economies. The fall in Brent Crude and Gold prices, and removal of issues around policy paralysis, regulatory irritants and administrative bottlenecks changed the outlook on India macroeconomic fundamentals. The FY16-FY19 targets at 8-10% for GDP growth, 4-6% for CPI, 3-3.9% for fiscal deficit and 0-2% for CAD are numbers that were not in the radar during July 2013-May 2014. Modi themes around effective and clean governance, Make-in-India vision, building skills and scale at good speed for higher productivity, infrastructure focus for scaling up manufacturing and agriculture sectors, financial inclusion to ensure economic well being translate into last mile social well being for inclusive prosperity, and many more are great news when the global economy is at squeeze. Modi made the World believe that India is the best destination for next couple of decades. The follow-up actions are from moving around the World with "red carpet" and "white flag" building deeper connect (and engagement) with developed and neighbouring countries. Internally, he sought cooperation with all non-BJP State Government leadership to work together for common cause of economic growth and poverty alleviation to make India a better place to live and make it comfortable for doing business in India. All taken, the positive shift is from risk of sovereign rating downgrade to expectation of upgrade; this kind of shift in outlook from before May 2014 to post NaMo period is dream come true! The other beneficial impact is from the provision of necessary bandwidth to RBI for shift from hawkish monetary policy stance (inflation defensive strategy) to dovish stance (growth supportive strategy) with delivery of 2-step 25 bps cut in policy rates between January to 1st week of March 2015.
All combined, investors built valuation premium around significant improvement in macroeconomic fundamentals largely driven by external cues, hope premium from scaling up in economic activity and euphoria premium on Modi execution capabilities. The outcome is obvious, triggering re-rating of India assets with sharp spike (from May 2014 to first week of March 2015) across asset classes; NIFTY up from 8th May 2014 low of 6638 to 4th March 2015 high of 9119 (by over 37%), Bank NIFTY outperformed NIFTY with rally from 7th May 2014 low of 12877 to 28th Jan 2015 high at 20907 (by over 62%) and India 10Y bond 8.40% 2024 gained from 8th August 2014 low of 98.15 (from over 8.65%) to 4th March 2015 high of 105.25 (to below 7.65%). Rupee did punch post-Modi high at 58.33 on 23rd May 2014 but lost 10.20% to post intra-2015 low at 64.28 (on 7th May 2015). While Rupee value adjustment is excessive, but seen in order if seen against RBI build-up of $ reserves and DXY rally from 8th May 2014 low of 78.90 to 13th March 2015 high of 100.39 by whopping 27%. The need to retain Rupee competitive to India exports and attractive for FDIs to participate in Make-in-India agenda is sensible.
What went wrong in the 1st week of March 2015 triggering sharp reversal?
The reversal from peak of 1st week of March 2015 (post delivery of 2nd round of rate cut) is sharp, but need to be seen as fair value adjustment given the economic consolidation phase in FY16 and risk of limited upside from high base effect, thus triggering profit booking taking money off the table. While there is no change in fundamental dynamics, the fear is also from unwind of part of the premium built around supportive external cues driven by recovery in Brent Crude from 45.19 to 69.63 by over 50% and dilution in FII appetite as FED prepares for shift into rate hike cycle in H2/2015. While the premium built on sustainable improvement in macroeconomic fundamentals is retained, euphoria premium built around NaMo is partially unwound given the political resistance to economic reforms policies and consequent risk of delay in execution of set vision objectives. All combined, unwind of luck and euphoria while retaining hope triggered correction (against long term bull trend) from 1st week of March 2015 to end of 1st year term of NaMo.
NIFTY pushed down by 12.30% (from 9119 to 7997), Bank NIFTY down by 17.50% (from 20907 to 17246), 10Y bond down from 105.25 to 102.50 for push back from 7.60 to 8.0% and Rupee down from 61.65 to 64.28 by 4.25%. Despite the sharp correction since 4th March 2015, the net year-on-year impact on NaMo 1st year score card is impressive; NIFTY up by over 15%, Bank NIFTY up by over 27%, 10Y bond up from over 8.65% to below 7.95% and Rupee down by 8.5% against rally in USD index by 20%. All taken, Indian financial asset markets have created significant wealth for retail and institutional investors during the 1st year of NaMo regime.
Rating score card for the India Inc CEO:
It is important to measure the performance across various levels - strategic intent and capabilities, building tactics to plan implementation and execution capabilities for on-ground impact. NaMo scores very high (9.5 on 10) on strategy and intent given the efforts he had taken to sell India story within and outside. The policy initiatives that have been taken to convert India as one of the best place for doing business and the connect made with all stakeholders is commendable. NaMo scores good on tactics (8.5/10) given the swift initiatives taken and some pending in pipeline against internal resistances. NaMo scores above average on execution (7/10) but the efforts taken to shake up the bureaucracy and administrative machinery, plugging revenue leakage and stringent measures to punish unfair practices in the system gets higher score despite lack of visibility on on-ground beneficial impact; it is fair to give the benefit of time. All combined, NaMo deserves high score of 8.3 on 10 for scripting a better face of India to the outside World and improving the sentiment and confidence of the people who have given this responsibility to NaMo.
Outlook for the 2nd year report card
The positive cues are from sustainable improvement in macroeconomic fundamentals; GDP growth stability above 8% against steady CPI at 4-5% will shift the system liquidity from deficit to surplus driving the overnight sovereign yield from Repo to Reverse Repo rate, fiscal deficit will trend into 3.5% from combination of growth driven income and arresting revenue slippage and collection inefficiencies. Stability in Brent Crude at $50-85 against expanded exports (and NRI/FDI inflows) will retain CAD/BOP in comfort to provide long term Rupee stability. The major risk is from implementation of execution plans built around strategies to upgrade India economic and social well being for move into the elite club of developed economies. The trump card is from possibility of sovereign rating upgrade in H2/FY16.
NIFTY has strong base at 7950 but do not rule out extended correction below 7950, seen as unsustainable. Strategic investors would be glad to absorb weakness below 7950 for minimum 15% upside reward for retest of 2015 high at 9119. If all goes well, NIFTY will derive momentum for Mount 10K. All taken, will not be surprised to see 15-25% rally from base around 7950 for better 2nd year performance over 15% of 1st year. Similar view on Bank NIFTY for base formation around 17250 for 21000 for over 20% gains.
10Y benchmark has upside potential at 7.25-7.75%. Given the best case Repo rate at 7.0-7.25%, 10Y bond upside is limited at 7.50-7.65% and would need shift of operating policy rate from Repo to Reverse Repo rate for extended gains below 7.50% for 7.25% and beyond. It would need to make the system lend to RBI for effective capital flows to fund capacity expansion. All taken, there is high probability of 10Y bond rally from current 7.95% to 6.75-7.50%. CPI stability at 4-4.5%, fiscal deficit control at 3.5-3.75% and Brent Crude stability at $45-70 will be the triggers for extended gains below 7.50-7.65%.
Rupee exchange rate has not caused pains to most stakeholders on move from 59 to 64. It may be a repeat performance this year too as worst case seen not beyond 68-69 and best case at 64-65 by mid May 2016.
All taken, NaMo 2nd year report card is expected to maintain the 1st year momentum with higher probability of exceeding expectations.
Job well done, Mr. Narendra Modi and best of luck for better performance in the 2nd year! God bless!!
Moses Harding
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